cr18203 PDF

IMF Country Report No.
18/203
NEW ZEALAND
SELECTED ISSUES
July 2018
This paper on New Zealand was prepared by a staff team of the International Monetary
Fund as background documentation for the periodic consultation with the member
country. It is based on the information available at the time it was completed on
June 5, 2018.
Copies of this report are available to the public from
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International Monetary Fund

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© 2018 International Monetary Fund

NEW ZEALAND
SELECTED ISSUES
June 5, 2018
Approved By Prepared by Dirk Muir, Ryota Nakatani, Yu Ching Wong (all

Asia and Pacific APD), and Zoltan Jakab (RES), with additional inputs from
Department Ioana Hussiada and assistance from Nadine Dubost (both
APD).
CONTENTS
INFRASTRUCTURE INVESTMENT IN NEW ZEALAND: GAPS AND MULTIPLIER

EFFECTS _______________________________________________________________________________ 4
A. Introduction _________________________________________________________________________ 5
B. A Baseline for the Infrastructure Investment Gap ____________________________________ 5
C. Benefits from Closing the Infrastructure Investment Gap ____________________________9
D. Closing the Gap as a Tool for Fiscal Policy _________________________________________ 13
E. Conclusions ________________________________________________________________________ 19
BOXES
1. The Six Step Methodology of the Global Infrastructure Outlook _____________________6
2. ANZIMF – The Australia-New Zealand Integrated Monetary and Fiscal Model _______9
3. Choosing the Output Elasticity for the Regions in Need of Development __________ 16
FIGURES
1. Global Infrastructure Needs versus Trends and Historical Averages __________________7
2. New Zealand’s Infrastructure Needs versus Comparators ____________________________7
3. Infrastructure Components for New Zealand _________________________________________ 7
4. Infrastructure Investment Gap for New Zealand ______________________________________ 7
5. Closing the Baseline Infrastructure Investment Gap by 2040 _______________________ 12
6. Infrastructure Investment Gaps_____________________________________________________ 13
7. Closing the Gap Earlier _____________________________________________________________ 14
8. Average Annual Household Income Growth, 2007-2017 ___________________________ 15
9. Matching Infrastructure Infrastructure Quality in Terms of Real GDP _______________ 18
NEW ZEALAND
TABLES
1. Closing the Infrastructure Investment Gap for Regional Development _____________________ 17
2. Infrastructure Quality Scores _______________________________________________________________ 18
References ____________________________________________________________________________________ 21
REVAMPING INFLATION TARGETING IN NEW ZEALAND 30 YEARS AFTER ITS

INCEPTION___________________________________________________________________________________ 23
A. Introduction________________________________________________________________________________ 23
B. Evolution and Performance of Inflation Targeting in New Zealand _________________________ 24
C. Operationalization of the Dual Mandate ___________________________________________________ 28
D. Conclusion _________________________________________________________________________________ 32
BOX
1. The Specification of the Output/Employment Goal for the Fed and the RBA _______________ 32
FIGURES
1. Dincer-Eichengreen Central Bank Transparency Index______________________________________ 25
2. Inflation and Expected Inflation ____________________________________________________________ 26
3. Output Gap in Selected Economies ________________________________________________________ 27
4. Official Cash Rate and Inflation and Output Gap ___________________________________________ 27
5. Revisions to the Projections in the Monetary Policy Statements____________________________ 29
6. Anchoring of Inflation Expectations (2015-2018) ___________________________________________ 30
7. Illustrative Loss Functions (2012-2018) _____________________________________________________ 31
TABLES
1. Established IFT Central Banks Endogenous Interest Rate Forecasts _________________________ 26
2. Macroeconomic Performance under Different Monetary Regimes (1981-2017) ____________ 27
3. Descriptive Statistics on Output Gaps (2009-2017) _________________________________________ 28
References ____________________________________________________________________________________ 33
HOUSING AFFORDABILITY IN NEW ZEALAND AND POLICY RESPONSE__________________ 35

A. Introduction________________________________________________________________________________ 35
B. How Much Has Housing Affordability Declined? ___________________________________________ 37
C. Supply-Side Policy Response to Improve Housing Affordability ____________________________ 42
D. Demand-Side Policy Response to Housing Imbalances ____________________________________ 44
E. Summary and Conclusions _________________________________________________________________ 45
2 INTERNATIONAL MONETARY FUND

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BOXES
1. Demand Impact of Macroprudential Policy_________________________________________________ 37
2. Private Rental Market ______________________________________________________________________ 42
TABLES
1. Illustrative Housing Affordability Scenario__________________________________________________ 41
2. Tax Residency of Buyer _____________________________________________________________________ 44
References ____________________________________________________________________________________ 47
PRODUCTIVITY AND PROFITABILITY IN NEW ZEALAND: THE ROLE OF LEVERAGE, R&D,

AND INVESTMENT __________________________________________________________________________ 48
A. Introduction________________________________________________________________________________ 48
B. Analysis ____________________________________________________________________________________ 49
C. Conclusion _________________________________________________________________________________ 53
FIGURES
1. Productivity and Profitability _______________________________________________________________ 49
2. Recent Development of Firm Performance Indicators ______________________________________ 50
3. Leverage, Investment and Profitability Before and After the GFC ___________________________ 51
4. Productivity Frontier versus Non-Frontier Firms ____________________________________________ 53
5. R&D Intensity and Leverage ________________________________________________________________ 53
TABLE
1. Pooled OLS Regression Results with Industry Fixed Effects _________________________________ 52
References ____________________________________________________________________________________ 54
INTERNATIONAL MONETARY FUND 3

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INFRASTRUCTURE INVESTMENT IN NEW ZEALAND:

GAPS AND MULTIPLIER EFFECTS1
• There has been an increased emphasis by the government on spending on
infrastructure. However, it is not clear from a long-term perspective if all of New Zealand
infrastructure needs will be met.
• The infrastructure investment gap to 2040 for New Zealand is quantified in the Global
Infrastructure Outlook by Oxford Economics and the G-20. The report estimates New
Zealand’s average infrastructure investment gap is around 0.3 percent of GDP per year.
• Closing the infrastructure investment gap is analyzed using ANZIMF (Australia-New

Zealand Integrated Monetary and Fiscal model). It is a version of IMF’s GIMF (Global
Integrated Monetary and Fiscal model), a micro-founded, overlapping generations dynamic
stochastic general equilibrium (DSGE) model, with a role for infrastructure investment.
• There can be further gains for the New Zealand economy from closing the
infrastructure gap. Infrastructure investment has been demonstrated to be productivity-
enhancing, with positive economy-wide spillovers. The long-term real GDP gain can range
from 0.65 to 0.8 percent relative to New Zealand’s outlook in the World Economic Outlook.
• The range of outcomes is a result of different forms of financing the additional public
infrastructure spending. The least productive financing is personal income tax (crowds out
consumption and distorts labor supply) followed by goods and services tax (only crowds out
consumption), with deficit financing (which, however, crowds out some private investment) as
the most productive.
• The government can use the closure of the gap to satisfy other fiscal policy objectives:
o The government could close the gap earlier. If the gap was closed by 2027, there would
be higher short-term gains in real GDP, with the same long-term gains. This would be
subject to the ability to quickly scale up the amount of infrastructure investment.
o The government could take the opportunity to further regional development. By

providing more funding to regions in need of development than implied by their current
shares in GDP, the regions could gain up to an additional 20 percent, translating to
5 percent for New Zealand as a whole.
o The government could aim for higher quality infrastructure investment. An illustrative
example is presented where New Zealand has Singapore-level quality scores. This could
be realized at least in part by a greater use of New Zealand’s public-private partnership
(PPP) framework.
1
Prepared by Dirk Muir (APD). The chapter benefited from valuable comments by the Treasury of New Zealand and
participants at a joint Treasury and Reserve Bank of New Zealand seminar.

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A. Introduction
1. There has been an increased emphasis by the government on infrastructure spending.

However, it is not necessarily clear from a long-term perspective if all of New Zealand’s
infrastructure needs will be met. This paper reports on the current and projected infrastructure
investment gap for New Zealand, using the analysis of Oxford Economics, for the Global
Infrastructure Hub. Moreover, given the magnitude of the gap, this paper demonstrates that there
can be further gains in terms of growth in the near- and medium-term that can be achieved by fully
closing said gap, using the IMF’s ANZIMF (Australia-New Zealand Integrated Monetary and Fiscal
model). These gains can be augmented by focusing on additional fiscal policy choices, such as the
time horizon to close the gap, regional development, or the quality of the infrastructure delivered.
2. The extent of the infrastructure investment gap is an important question, because it

represents foregone gains in productivity that would allow for higher growth. There is an
extensive literature that has demonstrated this theoretically (Aschauer, 1989), empirically (Bom and
Ligthart, 2014) and through model simulation and consideration of fiscal policy (Abiad and others,
2016). Much of the literature generally concludes that infrastructure of sufficient quality and quantity
can improve the quality of the workforce, the provision of capital, and firms’ access to domestic and
foreign markets. Interconnectivity is particularly important in a geographically distant country like
New Zealand, with concentrated but dispersed population nodes, and without any neighboring,
land-connected countries with which to trade. Governments can play an important role in closing
the gap, or in encouraging the private sector to do so.
B. A Baseline for the Infrastructure Investment Gap
3. The Global Infrastructure Hub is the primary source in this paper for the baseline
infrastructure investment gap. It is a G-20 initiative, that has published a Global Infrastructure
Outlook authored by Oxford Economics. 2 It forecasts current trends and needs for infrastructure
investment until 2040 (a 25-year period, starting in 2016), deriving the infrastructure investment gap
from calculating needed spending less spending based on current trends for seven sectors – roads,
rail, airports, ports, electricity, telecoms and water – for 50 countries, comprising over 85 percent of
global GDP. These seven sectors are considered core infrastructure, which is only a subset of the
standard definition of government investment in fixed capital in the national expenditure accounts,
as it excludes structures (such as hospitals, police stations, prisons, and schools) and capital
equipment (for example, ambulances and police cars, and military equipment).
4. Current trends and needs for the future are determined from extensive calculations.
Current trends for infrastructure investment extrapolate spending trends to 2040 through a
2
The report is the flagship publication for the Global Infrastructure Hub based in Sydney, Australia, and published
on-line at https://www.gihub.org/. The report’s author, Oxford Economics, is a private, global economics consulting
firm, focusing on macroeconomic forecasts. Oxford Economics and the Global Infrastructure Hub, Global
Infrastructure Outlook: Infrastructure Investment Needs, 50 Countries, 8 Sectors to 2040, can be found at
https://outlook.gihub.org/ (for the both database and the report).

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thorough analysis of the data for each country, combined with regression analysis for each of three
groups of countries (low and lower middle income, high middle income, and high income).
Infrastructure needs are computed for each of the seven sectors so that a country will match the 75th
percentile of current trends infrastructure stock per capita in their income group, adjusted for quality
considerations. Box 1 gives a more detailed explanation of the methodology.
Box 1. The Six Step Methodology of the Global Infrastructure Outlook
1. Compute the seven infrastructure stocks on a per capita basis for 2015 for all the countries in an
income group (such as the high-income group, to which belongs New Zealand.
2. Estimate single-equation models for each of the seven sectors using panel estimation, with a set of
explanatory variables usually drawn from a subset of GDP per capita, the manufacturing and
agricultural shares of GDP, population density, and the urban share of population, plus country-
specific fixed factors.
3. Given the forecasts of the explanatory variables, forecast infrastructure stocks per capita to 2040.
These are then converted using perpetual inventory equations of the form 𝐾𝐾𝑡𝑡 = 𝐾𝐾𝑡𝑡−1 (1 − 𝛿𝛿) + 𝐼𝐼𝑡𝑡 to
calculate the current trend investment for each of the seven sectors.
4. Using the single-equation models, estimate what the value of the stocks should have been in 2015
given explanatory variables, to compute the expected infrastructure stock per capita.
5. Using the infrastructure quality measures for each country (from the World Economic Forum’s Global
Competitiveness Report 2014-15), derived a quality-adjusted expected infrastructure stock per capita.
6. Compare the quality-adjusted expected infrastructure stock per capita across countries in a country
grouping, to determine the 75th percentile, from which comes for each country, in combination with
the perpetual inventory equation, its investment needs.
Infrastructure investment gap = investment needs – current trends in investment
5. The global infrastructure investment gap is estimated at 2015 US$94 trillion between
2016 and 2040. 3 This is a gap of 19 percent against the current trend investment in infrastructure
extrapolated to 2040, an average of 2015 US$3.7 trillion per year. It implies that global infrastructure
investment spending as a share of GDP should be 3.5 percent now, versus 3.0 percent actual. All the
infrastructure sectors have higher needs than current trends, roads being the greatest (Figure 1).
6. New Zealand has a small gap, but not relative to many other advanced economies.
According to the Global Infrastructure Outlook, New Zealand’s overall gap from 2016 to 2040 is
roughly 9.5 percent of GDP, implying cumulative infrastructure investment needs of 2015 US$190
billion, versus the current cumulative trend spending of 2015 US$171 billion. This translates into an
infrastructure investment spending gap of almost 0.3 percent of GDP per year until 2040, smaller
3
Values in level terms are in constant 2015 U.S. dollars, abbreviated as 2015 US$.

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than Australia and the United States, but larger than other key advanced economies and China
(Figure 2).
Figure 1. Global Infrastructure Needs versus Figure 2. Infrastructure Needs versus

Trends and Historical Averages Comparators
(Percent of global GDP per year) (Percent of GDP per year)
Source: Global Infrastructure Outlook, Oxford Source: Global Infrastructure Outlook, Oxford
Economics. Economics.
Figure 3. Infrastructure Components Figure 4. Infrastructure Investment

(Percent of GDP per year) (Percent of GDP)
Source: Global Infrastructure Outlook, Oxford Sources: Global Infrastructure Outlook, Oxford
Economics. Economics; and IMF staff calculations.
7. New Zealand’s infrastructure investment gaps for the seven sectors differ from the
global picture (Figure 3). There has been extensive investment in roads, and current trends continue

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to indicate this to be the case, matching the investment needs. Stronger needs exist in the rail and
electricity sector, since New Zealand historically has had weak rail linkages (because of difficult
terrain on each island with small inland populations). There is also a recognized need to upgrade
and expand the power grid.
8. An aggregate infrastructure investment gap as a share of GDP is constructed from

2018 to 2040 (Figure 4). It uses the forecasts for GDP from the IMF’s World Economic Outlook, April
2018 (WEO) and infrastructure investment from the Global Infrastructure Outlook. The increased
spending in the FY2016/17 fiscal outcomes and FY2017/18 fiscal budgets are roughly consistent
with closing the gap in 2016 and 2017, so the gap used here is zero in 2016 and 2017. The gap from
2018 forward for New Zealand differs slightly from that of the Global Infrastructure Outlook as
nominal GDP growth is more variable in the WEO until 2023, and then slightly higher thereafter. The
two most important gaps are in rail (over 0.1 percent of GDP year) and electricity (almost 0.1 percent
of GDP per year).
9. However, the measurement of the gap by this methodology should be treated with
care, especially since it may not account for risks specific to New Zealand. This sectoral analysis
has its limitations, being based strongly on an econometric methodology. The actual measured gaps
would also be affected by project-specific analysis of the benefits and costs necessary to confidently
determine the prospective gains from further infrastructure investment. Overall, risks are such that
the baseline measure of the infrastructure gaps is a most likely a low estimate. They also relate to
the current split between the three major urban areas – Auckland and its satellites, Hamilton and
Tauranga; Wellington and its suburbs; and Christchurch – and the rest of country, often referred to
as “the regions,” with particular ones in need of development as they have less and lower-quality
infrastructure, fewer employment opportunities, and/or greater inequality and poverty. There are
three of these risks, which are interrelated and therefore reinforce one another:
• Water-related infrastructure (for the “three waters,” potable, waste and storm) has often
reached the end of its useful life. This is particularly true in the regions, and may not be
accurately reflected in the service-life data from the advanced economies used to construct the
depreciation rates for water infrastructure. Local governments are most likely falling behind on
their maintenance needs, currently underspending capital budgets by up to 30 percent
(Controller and Auditor-General, 2017).
• The estimates of population growth for the baseline gap is based on historic norms.
However, net migration has been at record highs for a sustained period of time, since 2014.
Repeatedly, expectations that net migration would begin to decline to historic norms have been
dashed, and the upside risk that net migration may not return to its historical average soon is
still very much in play.
• The placement of infrastructure is based on current patterns of urbanization. Most

infrastructure needs are assumed to be in the three major urban areas, following historic trends,
requiring mostly new infrastructure. However, a possible solution is to encourage more
population growth in the regions in need of development. These regions’ infrastructure needs

NEW ZEALAND
would be greater, as they are more isolated, have less existing infrastructure to serve as a kernel
for new construction, and have more infrastructure in need of improvement, in comparison to
adding or rebuilding neighborhoods in the major urban areas.
C. Benefits from Closing the Infrastructure Investment Gap
10. There are benefits to closing the gap for New Zealand. These benefits can be quantified
with the help of ANZIMF, which a version of the IMF’s GIMF (see Box 2 for further details).
Box 2. ANZIMF – The Australia-New Zealand Integrated Monetary and Fiscal Model
ANZIMF is an annual, multi-region, micro-founded general equilibrium model of the global

economy. It is based on the IMF’s Global Integrated Monetary and Fiscal model (GIMF), with supporting
documentation that is broadly applicable to ANZIMF (Kumhof and others, 2010, and Anderson and others,
2013). Structurally, each country/regional block is close to identical, but with potentially different key
steady-state ratios and behavioral parameters. This exercise focuses on New Zealand, and the fiscal block.
Consumption dynamics are driven by saving households and liquidity-constrained (LIQ) households.
Saving households face a consumption-leisure choice, based on the overlapping generations (OLG) model
of Blanchard (1985), Weil (1989) and Yaari (1962) where households treat government bonds as wealth since
there is a chance that the associated tax liabilities will fall due beyond their expected lifetimes, making the
model non-Ricardian and endogenizing the long-term determination of the real global interest rate to
equilibrate global savings and investment. The real exchange rate serves to adjust each country’s saving
position (its current account and associated stock of net foreign assets) relative to the global pool. LIQ
households cannot save, consuming all their income each period, amplifying the model’s non-Ricardian
properties in the short term.
Private investment relies on the Bernanke-Gertler-Gilchrist (1999) financial accelerator. Investment
cumulates to the private capital stock for tradable and nontradable firms, which is chosen by firms to
maximize their profits. The capital-to-GDP ratio is inversely related to the cost of capital, which is a function
of depreciation, the real corporate interest rate, the corporate income tax rate, and relative prices, and an
endogenously determined corporate risk premia.
Government absorption consists of exogenously determined spending on consumption goods and
infrastructure investment. Both affect the level of aggregate demand. Spending on infrastructure
cumulates into an infrastructure capital stock (subject to constant but low rate of depreciation of 5.3
percent). A permanent increase in the infrastructure capital stock permanently raises the economy-wide
level of productivity. The calibrated output elasticity with respect to core infrastructure capital is 0.170 (Bom
and Ligthart, 2014).
Trade is tracked bilaterally between all regions. There are flows for goods, services, and commodities,
and they react to demand, supply and pricing (i.e. the terms of trade and bilateral real exchange rates)
conditions. Commodities trade, and its related demand and supply equations, are based on food products,
as New Zealand has strong exports for dairy products, meat, and kiwi fruit.
The nominal side of the economy depends on implicit Phillips’ curves and monetary policy. The core
price is the consumer price index, CPI, while relative prices mimic the structure of the national expenditure
accounts. There is also wage inflation, which is implicitly a key driver for CPI inflation. In the short term, the
nominal side of the economy is linked to the real side through monetary policy, which is conducted under a

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Box 2. ANZIMF – The Australia-New Zealand Integrated Monetary and Fiscal Model
(concluded)
CPI inflation targeting regime, where with an interest rate function returns expected inflation to target over
several years.
Fiscal policy is driven by a sufficiently detailed government sector that can reproduce simplified fiscal
accounts for each country. Fiscal policy aims to maintain a debt target (expressed in flow space as a deficit
target) using at least one of seven policy instruments. On the spending side, these are government
consumption, spending on infrastructure spending, general lumpsum transfers to all households (such as
pensions, aged care provisions, unemployment insurance) and lumpsum transfers targeted to LIQ
households (such as welfare, certain pensions). On the revenue side, there are taxes on consumption (the
goods and services tax, GST), personal income (PIT) and corporate income (CIT).
The government does not have to be the sole supplier of infrastructure investment. Nontradable firms
can be in public-private partnerships (PPPs), by diverting some of their investment into the infrastructure
capital stock, which will still register in the national expenditure accounts as private business investment.
Firms can either be repaid for their expenses in the future by the government or through a revenue stream.
The revenue stream option does not appear explicitly in the model, since it is merely a circular reshuffling of
a user fee from households to firms, which would then return to households, as owners of the firms. The
government can also provide equity investment injections into the private sector, which will then be
converted by firms over some pre-determined time horizon into private business investment, that will
contribute to the infrastructure capital stock rather than the private business capital stock.
11. Any additional infrastructure spending requires financing. There are two feasible
financing choices for the government – increasing the deficit, or using funds from general revenues.
Financing through spending cuts (which would most likely be reduced government employment)
would be a harder-to-implement, time-consuming process, whereas raising debt and revenues can
be done relatively rapidly in the New Zealand political system, which has only a one-house
legislature, (often) with a majority government in power.
• In the case of deficit financing, the government would borrow to finance their expenditures,
through its standard mechanisms, and would increase the level of debt permanently.
• In the case of funding from general revenues, the most logical approach would be to increase
one or both of the personal income tax (PIT) and the goods and services tax (GST).
12. There are limitations to using model simulations to capture the economic outcomes
from closing an exogenously specified infrastructure investment gap. First, most importantly,
there is uncertainty as to quantification of the pass-through of infrastructure investment and stock
to productivity growth. Second, the caveats associated with ANZIMF are limitations of this analysis,
such as the under-responsiveness of trade flows (common to many DSGE models). Third, the
methodological concerns for constructing the gap itself can produce misleading results if the gap is
quantified incorrectly. 4 Finally, because closing the gap will stimulate the economy, it will also
increase GDP which would affect somewhat the demand for infrastructure, changing the investment
4
These can found in the Global Infrastructure Outlook, pp. 179-180. The most interesting concern, conceptually, is
that technological innovations over the forecast could fundamentally change the role and provision of infrastructure.

NEW ZEALAND
needs, and hence the infrastructure investment gap – a feedback effect that is ignored here, but may
not be significant given New Zealand’s small gap.
13. Current infrastructure spending by the New Zealand government is still consistent
with the forecast of the gap used here. The Global Infrastructure Outlook dataset was built
contemporaneously with the FY2015/16 budget paths, and tried to capture the trends current at
that time, which may have even exceeded the capital allowances stated in the budget. The budgets
in FY2016/17 and FY2017/18 increased spending on infrastructure to close the gap for the most part
for those two years, and possibly out to FY2020/21, primarily by accounting for stronger-than-
expected growth in GDP and population. Therefore, the gap in the short term may be somewhat
over-estimated, although other factors also point to some degree of underestimation, as outlined at
the end of the previous section.
14. Figure 5 illustrates the effects of closing the New Zealand gap. It assumes participation
by both the national government and local governments (who derive some financing, but not all,
from the national level). The figure shows the first 10 years (using lines) followed by snapshots for
the end-point at 2040, and the long-term steady-state result from maintaining the new higher level
of the infrastructure capital stock (using vertical bars). There are three variants for financing the
closure of the gap: deficit financing by government (blue line and bars); government financing using
PIT only (red line and bars); and government financing using both PIT and GST (green line and bars).
15. In the long term, real GDP would be as much as 0.8 percent higher than otherwise, for
a long-term multiplier of around 2.7. The small gain reflects that New Zealand’s gap is small. With
higher productivity, there is a slight long-term depreciation in the real effective exchange rate,
allowing for stronger exports. Even though imports cost more, consumption is still between 0.3 to
0.6 percent higher in the long term. A higher infrastructure level means a permanent increase in the
level of productivity, passing to the level of labor demand and therefore to wages and labor income,
as well as demand for capital and private business investment. Firms would have more income, and
would be a source of further wealth to households (their owners) further stimulating consumption.
However, there are variations among the three types of financing.
16. Deficit financing would provide the greatest gains. In the short term, deficit financing
would be most advantageous, although the government would face a permanent 5.5 percent
increase in the government debt to GDP ratio, which would slightly crowd out private business
investment, offsetting some of the productivity gain from the additional infrastructure investment.
However, the cumulative deficits required out to 2040 are closer to 6.6 percent of GDP, meaning
that the additional growth from infrastructure investment reduces the government debt to GDP
ratio in the long term by 1.1 percentage points. Deficit financing also increases demand for private
saving flows, some of which come from abroad, leading to a worsening of the current account
deficit. In the short term, this drives an additional appreciation of the real effective exchange rate,
until the economy-wide productivity gains are large enough to lead to a long-term depreciation,
relative to the baseline of WEO-consistent forecasts.

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Figure 5. Closing the Baseline Infrastructure Investment Gap by 2040

(Deviations from WEO-consistent forecasts)
Note: The bar marked “SS” is the steady-state value.

Source: IMF staff calculations.

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17. Financing with PIT and/or GST would be less beneficial and reduce GDP gains. Such
taxation would be a drag on consumption, especially during the initial phases of closing the gap, as
liquidity-constrained households would adjust their spending downwards immediately. Using PIT
financing alone would reduce the gains accruing to the economy the most, as higher PIT not only
reduces consumer buying power, it taxes a factor of production directly, and reduces labor
productivity, counteracting some of the gains from additional infrastructure investment. Overall,
there is less demand for foreign financing – what remains is driven by borrowing for consumption,
offset by weaker investment. Therefore, there is less of a short-term appreciation of the real effective
exchange rate.
D. Closing the Gap as a Tool for Fiscal Policy
18. Closure of the infrastructure investment gap can be used as tool to further fiscal policy
goals. As the government closes its gap, it could alter its focus in one (or more) of three ways for
additional benefits: 1) increase the amount of investment in order to reach the desired infrastructure
capital stock earlier, allowing New Zealand to maximize its gains sooner; 2) increasing emphasis on
spending in regions in greater need of development; and 3) improving the quality of the
infrastructure delivered, which could include public-private partnerships (PPPs).
Focus on Closing the Gap Sooner
19. The government could Figure 6. Infrastructure Investment Gaps

alter the length of time taken to (Percent of GDP)
close the gap. Instead of closing the
gap over 25 years, the government
could choose to help kick-start
short-term growth by closing the
gap in 10 years, using deficit
financing (Figure 6). Although long-
term benefits would remain
unchanged, doing more than closing
the gap would presumably accrue
few extra benefits. The government
would have to increase their debt
load more quickly, and this may pose
a risk to credit ratings, and could
Sources: Global Infrastructure Outlook, Oxford Economics, and
impose additional sovereign risk
IMF staff calculations.
premia, although those risks are not
quantified here. As moving from under 0.3 percent of GDP to over 0.5 percent of GDP for
infrastructure cannot be done easily (because of procurement processes, and selection processes
involving cost-benefit analyses), it is assumed to be phased in over four years.
20. Figure 7 compares the benchmark scenario (blue line and bars) against the 10-year
scenario with deficit financing (red line and bars). The long-term real GDP gains around the

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same as in the benchmark scenario, at 0.8 percentage points. But by shortening the time horizon,
economic gains are moved forward, and there is much more fiscal stimulus in the short term. Real
GDP increases much more rapidly in the short term, adding twice as much to growth over the first
10 years relative the benchmark scenario. Consumption also increases more strongly. However, if the
government does it solely through deficit financing, there is greater crowding out of private
business investment in the first several years, also leading to crowding out of labor demand and
income, and therefore consumption. There is increased demand for foreign financing through the
current account, leading to a stronger short-term real effective exchange rate appreciation, although
the permanent productivity effects still lead to a long-term depreciation of the real effective
exchange rate. Overall, changing the speed at which the gap closes can provide short-term benefits
to growth, and fiscal policy can provide a more prominent role in short-term demand management,
but with productive spending ensuring long-term gains.
Figure 7. Closing the Gap Earlier

Note: The bar marked “SS” is the steady-state value.

Source: IMF staff calculations

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21. In practice, changing the horizon for fiscal policy implementation requires careful
planning and consideration. It may not be possible to reduce some projects to a shorter horizon
and if the economy is already in an expansionary phase, it may be difficult to attract the resources
required to carry out the investment. As of 2018, New Zealand has little spare capacity in its labor
and capital markets, and might not be able to absorb the needs of a faster expansion of
infrastructure investment.
Focus on Furthering Regional Development
22. The government can augment its regional development goals when closing the
infrastructure gap. The results so far rest on the assumption that benefits in New Zealand are
homogenous, when there may be regional differentiation. By increasing infrastructure investment in
regions in need of further development, New Zealand opens up the possibility of greater benefits,
not only in terms of the level of real GDP, but also to meet other (social) goals, such as alleviating
inequality and poverty.
23. The infrastructure gaps in the Global Infrastructure Outlook do not depend on their
physical location within New Zealand. Many of the gaps are dependent on location of the
population, so placing new infrastructure in the regions can encourage populations to settle
elsewhere, in addition to closing the gaps in the regions. Successful redirection of the population
would most likely depend on other policies outside of the provision of infrastructure, but that lies
outside the scope of this paper, and it is assumed for the discussion that follows that the proper
policies are in place.
24. In New Zealand, regions in need of Figure 8. Average Annual Household Income
further development generally coincide Growth, 2007-2017
with poorer regions. These regions are (Annual Percent Growth)
defined in this paper as a subset of New Growth
Zealand’s 16 local government areas – Rates
Northland, Waikato, Bay of Plenty, East Coast
(Gisborne), Hawke’s Bay, Manawatu-
Whanganui, Tasman/Nelson, West Coast, and
Southland, which have been the increased
focus of regional development efforts in
recent years (MBIE, 2017) and often have had
low household income growth (Figure 8).
25. Regions in need of further

development might have a higher output
elasticity of public capital than the rest
New Zealand, allowing for greater GDP Source: MBIE (2017).
gains than under the benchmark scenario.
This is supported by the available literature (Box 3). As an illustrative example, an output elasticity of

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Box 3. Choosing the Output Elasticity for the Regions in Need of Development
A revised output elasticity with respect to core infrastructure capital is chosen based on available
empirical studies. Recent literature focuses on the United States, Italy and Spain. That of Italy and Spain
often look at the regions based on their income disparities, and is more applicable to the New Zealand case.
It suggests that regions in need of development can benefit more from increased infrastructure investment.
Literature on Italy focuses on the split between the more industrialized, urbanized North, versus the
poorer, more rural South. Bonaglia and others (2000) find that much more of TFP growth in the South
than in the North is attributable to public investment. Furthermore, by using a production function approach
over 1970 to 1994, they find an output elasticity for the South of about 0.495, versus between 0.1 to 0.2 for
the regions of the North. This finding is supported by Marrocu and Paci (2008), using a later sample from
1996 to 2003 under a different production function, with elasticities for core infrastructure of 0.185 for the
South, 0.095 for the North, and 0.119 for all of Italy. Percoco (2004) considers the role of efficiency in
regional public infrastructure investment, both technical (physical transformation of inputs) and allocative
(choosing between factors of production). The frontier for technical efficiency, at 100, is of interest for this
paper, and all of Italy falls short by 21 percent, while the South does even worse, by 25 percent.
The literature for Spain focuses more on the individual regions, and has a fuller consideration of the
elasticities from infrastructure investment within the region (“inside investment”), and spillovers
from investment elsewhere (“outside investment”). Marvão Pereira and Roca-Sagales (2007), using
SVARs for Spain and its regions based on data from 1970 to 1995 find an elasticity of 0.523 for core
infrastructure. The regions in need of development comprise less than 40 percent of GDP and have
elasticities that are 20 to 30 percent higher when combining effects of inside and outside investment.
Marquez and others (2011), using an SVAR approach from 1972 to 2000, agree with this finding, but draw a
distinction between short- and long-term responses of GDP, finding that private investment benefits from
extra public investment in the long term. However, in the short term, there is a tendency for public
investment to serve as a substitute for private in these regions, while they act as complements in wealthier
regions like Cataluña, reducing the short-term effectiveness for regional development. Finally, Puente
(2017), using a production function approach over 1980 to 2015, generally supports the finding that the
regions have higher returns to public investment, and have led to better GDP growth per capita. Output
elasticities of public capital seem to be about 20 to 30 percent higher for these regions.
For New Zealand, Cochrane and others (2010) concludes that an increase in regional infrastructure
spending increases population growth, real income and land values, but is itself endogenous and
spatially correlated. While the individual regions are used in their estimation of a four-equation model
under 3-stage least squares, there are no estimations for individual regions presented. But the methodology
better captures interregional spillovers and demonstrates the positive impact on productivity for New
Zealand, which had been in doubt for New Zealand as presented in Kamps (2006) for OECD countries.
Based on this information, the regions in need of development should have an output elasticity
somewhere in the range of 20 to 50 percent higher than the rest of New Zealand. Often the elasticities
in level terms are notably higher than the modern literature, summarized in Bom and Ligthart (2014), with its
output elasticity with respect to core infrastructure of 0.17. For this application, the illustrative output
elasticity chosen is 30 percent higher, at 0.221. The effective output elasticity for New Zealand will be a
weighted average between that of the regions in need of development and the rest of New Zealand
(imputed as a value of 0.152 from the baseline calibration of 0.17 and the GDP share of the rest of New
Zealand), where the chosen weights are explained below when presenting each illustrative scenario.

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0.221 is used. In the benchmark scenario used so far, with a New-Zealand-wide elasticity of 0.170 (as
found in Bom and Ligthart, 2014), it is assumed that infrastructure investment is distributed by the
regions’ share of total GDP. Given that these regions account for 26.0 percent of total GDP on
average from 2012 to 2016, the implied elasticity for the rest of New Zealand is 0.152. On a per
capita basis, there has been underinvestment in the regions in need of development, thereby
redistributing the stock of infrastructure over time to the rest of New Zealand. Five additional cases
are considered:
• Weight the distribution of infrastructure based on the average population from 2012 to
2016, so that these regions receive 32.6 percent of the total investment, implying a New
Zealand-wide output elasticity of public capital of 0.175. Using population as a basis is more
likely to maintain the current ratio of infrastructure between these regions and the rest of New
Zealand.
• Repeat the population-weighted distribution of infrastructure investment, but with an

additional efficiency assumption, using Italy as an analogous case (from Percoco, 2004,
outlined in Box 3), that overall efficiency is 5 percent lower in these regions.
• Repeat both scenarios, but augment the population weight for the regions in need of
development by 25 percent so that these regions receive 40.8 percent of infrastructure
investment, lifting the output elasticity to 0.180.
• An illustrative scenario where the infrastructure gap is solely closed through investment in
these regions, to demonstrate the upper bounds of the possible gains, but ignoring the obvious
point that the rest of New Zealand does indeed face some infrastructure gaps that need to be
addressed.
26. Devoting more Table 1. Closing the Infrastructure Investment Gap for
resources to regional Regional Development
development will augment (Deviations from WEO-consistent forecasts)
the outcome. It will make more Aggregate Aggregate Aggregate Regional
of a difference for those regions Output Real GDP Real GDP Real GDP
in need of further development, Elasticity Full Effect Lower 1/ Full Effect
but not so much at the Benchmark 0.170 0.80 … 0.21
aggregate level. Table 1 shows Population Share 0.175 0.82 0.81 0.23
the long-term outcomes on real Population Share 0.180 0.84 0.83 0.25
GDP for the five scenarios. Plus 25 Percent
There are small gains for New Illustrative 0.221 0.98 … …
Zealand, usually less than “Regions Only”
0.1 percent of GDP in the long 1/ “Lower” means that technical efficiency is 5 percent lower in the
term. However, this is only from regions in need of development relative to the rest of the country.
a shift of spending from the rest Source: IMF staff calculations
of New Zealand of 6.6 percentage points of spending when using the population share, or almost
8.3 percentage points using the augmented share. Most of the gain should accrue to the regions in

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need of development – their spillovers to the major urban areas are slight; instead the regions are
usually subject to spillovers from the major urban areas (taking Marquez and others, 2011, as an
indication). If the benchmark gains are attributed to these regions based on their GDP share, then
they receive 0.21 percentage points of the increase in GDP. This will increase to 0.25 percentage
points under the scenario based on the augmented population weights.
Focus on Improving the Quality of Infrastructure Investment
27. Another way in which the return to infrastructure investment can be augmented is by
improving the quality of the infrastructure. While New Zealand generally produces high quality
infrastructure for the funds it spends, it is not the leader among the high-income group; rather it is
Singapore, as seen by the quality scores presented in Table 2 from The Global Competitiveness
Report (World Economic Forum, 2017). In this case, “quality” can be thought of as some combination
of more efficient use of funds and better technology, which is a similar but less technical definition
than those for allocative and technical efficiency discussed in the previous section.
28. Applying a “conversion factor” would bring the quality of New Zealand infrastructure
to the same level as Singapore, based on their quality scores. The conversion factor is the
weighted sum of the ratio of Singapore quality score to that of New Zealand equivalent for each of
the five sectors (energy, airports, ports, rail, and roads), where the weights are based on the average
share of each sector in New Zealand’s infrastructure capital stock. It is assumed that the conversion
factor is also valid for the water and telecommunications sectors. The aggregate conversion factor of
1.23 is then applied to the benchmark rate of pass-through of new infrastructure capital into New
Zealand’s productivity.
Table 2. Infrastructure Quality Scores Figure 9. Matching Infrastructure Quality in

(Range of 1 to 7; 7 is best) Terms of Real GDP
New Zealand Singapore
Energy 6.5 6.9
Airports 5.6 6.9
Ports 5.5 6.7
Rail 3.5 5.9
Roads 4.7 6.3
Source: Global Competitiveness Report, 2017-18. Note: The bar marked “SS” is the steady-state value.
Sources: Global Infrastructure Outlook, Oxford
Economics; and IMF staff calculations.
29. Figure 9 presents the outcomes for New Zealand if its new infrastructure had the same
quality as in Singapore. The blue line and bars are the benchmark scenario, while the scenario with

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improved quality is the red line and bars. The infrastructure investment gap is unchanged, as is the
spending is required to close it. For ease of comparison, only the case of deficit financing is
considered. However, the differences between the two scenarios are very similar under the variants
for financing the gap using PIT or PIT and GST.
30. The scenario demonstrates that New Zealand could experience further gains by
improving their quality scores. If the quality of the newly-built infrastructure was at levels
achieved in Singapore, real GDP would be almost 0.2 percentage points above the gains in the
benchmark scenario, so that closing the infrastructure gap would results in a 1.0 percent gain in the
long term. Most of the effects on the economy are the qualitatively the same as the benchmark
scenario, but quantitatively amplified. However, improved quality does not directly incur additional
government spending, thereby avoiding any additional government debt.
31. The government could help realize these gains by relying more on PPPs. New Zealand
already has a PPP framework in place. Its goal is not to move funding needs off the government
books; rather, the main expected benefits are greater efficiency gains from using private sector
expertise and knowledge when building new infrastructure (Treasury, 2015). Risks are supposed to
be mitigated and allocated between the public and private sectors through the agreements put in
place to govern the process, as suggested in the literature (Corbacho and Schwartz, 2008).
E. Conclusions
32. Summary. There has been high quality work done to quantify the infrastructure gap for
New Zealand by Oxford Economics on behalf of the Global Infrastructure Hub, drawing on
international experiences and local data sources, but recognizing the risk that the infrastructure gap
may be even larger than that stated in this work. This paper provides further analysis about the
effects on New Zealand’s economy of closing the infrastructure gap. Closing the gap has
quantifiable benefits, not just because it is a short-term stimulus to aggregate demand, but because
of longer-lived effects on productivity, benefiting all sectors of the economy.
33. The form of financing for the additional spending matters. While there are economic
gains in all cases, the magnitude of those gains depends on whether the spending relies on deficit
or tax financing. In the long term, because of the small amounts required to finance the expenditure,
financing by deficits are preferable to tax financing. However, deficit financing has its risks. If the
infrastructure needs were much greater, the level of debt incurred would be costlier in the long
term, and could outweigh the productivity gains in the economy by crowding out too much
investment, and possibly lead to an additional sovereign risk premium on New Zealand’s borrowing
from abroad.
34. Closure of the gap can be used to further fiscal policy objectives. By changing or
augmenting its focus, the government could provide even more benefits. Three examples on which
the government could focus are:

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• Shortening the time horizon over which it works to close the infrastructure investment gap to
achieve the same level of infrastructure stock in the long term. Consequently, the government
could provide additional short-term stimulus to the economy.
• Furthering regional development. Evidence from other countries suggest that regions in need
of development have a higher output elasticity with respect to infrastructure capital. Therefore,
New Zealand could increase their returns to infrastructure investment by ensuring that closing
the infrastructure gap does not just build on patterns that favor the major urban areas, but
pushes more to its regions in need of further development. However, the success of such a
strategy would depend on other policies to encourage the utilization of that infrastructure
where it is installed, primarily by encouraging the relocation of firms and households.
• Improving the quality of infrastructure investment. An illustrative example is presented

where New Zealand has Singapore-level quality scores. This could be at least partially achieved
by using the existing PPP framework.
35. There are prospective gains from closing New Zealand’s infrastructure gap. New
Zealand has improved its infrastructure spending in the past several years. Nonetheless, there is
scope to expand it further, to reduce its (admittedly small, but probably understated) infrastructure
gap to match other advanced economies, and possibly help with regional development concerns.

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REVAMPING INFLATION TARGETING IN NEW

ZEALAND 30 YEARS AFTER ITS INCEPTION 1
A. Introduction
1. Almost 30 years after establishing the first inflation targeting regime, New Zealand
has embarked on a review of the Reserve Bank Act. The government initiated the review in late
2017. The review process consists of two phases. Phase One deals with the monetary policy
framework and the related decision-making, while Phase Two will review the financial and other
policies of the Reserve Bank of New Zealand (RBNZ). In the first phase, an Independent Expert
Advisory Panel was formed to recommend changes to the Act to (i) ensure that monetary policy
decision-makers give due consideration to maximizing employment alongside price stability;
(ii) provide for a committee approach for monetary policy decisions; and (iii) consider whether
changes are required to the role of the RBNZ Board of Directors. Terms of reference for Phase Two,
which is expected to start in the second half of 2018, will be issued soon, after the Independent
Expert Advisory Panel has made its recommendations for the scope of the review.
2. Cabinet decisions on changes to the Reserve Bank Act following Phase One
recommendations are now awaiting legislation. After considering the Panel’s recommendations 2
the Cabinet decided on the way forward, agreeing to add an employment objective to the price
stability objective and to delegate monetary policy decision-making to a monetary policy committee
(MPC). 3 The RBNZ Board of Directors will be responsible for monitoring performance of the MPC
and its individual members in their duties. The review also highlighted that the desired outcome is
for decision making to be less governor-centric and a Monetary Policy Committee will be formed.
These modifications will be captured formally in an amending bill to the Reserve Bank Act in the
coming months. 4
3. Overall, Phase One of the review has not led to fundamental changes to the monetary
policy regime and is unlikely to result in changes in monetary policy conduct. The RBNZ will
continue to operate its successful flexible inflation targeting regime. As argued below, the latter has
already involved de facto output and employment stabilization. While the decision-making model
will change, the operational independence of the RBNZ has only been affected at the margin.
Monetary policy making remains a delegated policy mandate. The new Policy Targets Agreement
(PTA) signed on 26 March ahead of a new Governor taking office already incorporates an
employment objective along the traditional price stability objective (RBNZ, 2018a). The RBNZ is thus
1 Prepared by Zoltan Jakab (RES). The chapter benefited from valuable comments after a presentation at the RBNZ.
2 See Independent Expert Advisory Panel (2018).
3 See Cabinet Paper (2018).
4 See RBNZ (2018a).

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operating under a dual mandate, similar to the Reserve Bank of Australia (RBA) and the U.S. Federal
Reserve System (Fed).
4. This paper reviews the backdrop to the revamping of the inflation targeting
framework in New Zealand. Section B reviews the recent experience with the flexible inflation
targeting regime, highlighting that the regime has been successful both in stabilizing inflation and
keeping it low and in avoiding large output fluctuations. Still, the relatively long recent episode of
inflation being below target highlights the risk of a rigid employment objective, as uncertainty about
the extent of slack in overall economy or in the labor market can be sizeable. Section C reviews the
main aspects that the dual mandate framework will require for the operationalization of monetary
policy. Section D concludes.
B. Evolution and Performance of Inflation Targeting in New Zealand
From Strict to Flexible Inflation Targeting
5. The practice of inflation targeting in New Zealand has evolved over the time. New
Zealand was the first country to adopt Inflation Targeting (IT) in 1989. The specifics of the objectives
and the operationalization of inflation targeting have changed considerably over time even though
the overarching objective of price stability and other features of inflation targeting put in place in
the 1989 Revision of the Reserve Bank Act have not changed. Most noticeably, the regime evolved
from a strict inflation targeting regime to a more flexible inflation targeting regime (McDermott,
2018).
6. Following McDermott (2018), there have been three periods in the evolution from
strict to more flexible inflation targeting. In the first period, the period of strict inflation
targeting, the focus was on achieving inflation such that annual inflation was to remain inside the
target band, and the RBNZ had to explain deviations resulting from shocks outside of the RBNZ’s
control. There were no secondary considerations specified in the PTAs. In the second period, from
the late 1990s to the end of the 2000s, inflation targeting became increasingly flexible. Flexibility
refers to the fact that the time to achieve the target was implicitly lengthened, while the shocks
listed in the PTAs that could result in permissible deviations of actual inflation from target became
more illustrative rather than exhaustive. As of 2002, the inflation objective was to be achieved over
the medium term, rather than on an annual basis. Also, since 1999, so-called secondary
considerations were established in PTAs. The RBNZ was set to seek to avoid unnecessary instability
in output, interest rate and exchange rates. Finally, in the third period, this decade, PTAs clarified
that the focus was on the 2 percent midpoint of the target range, while other secondary
considerations were added to the framework (asset prices, financial stability).
7. In the transition from strict to flexible inflation targeting, the RBNZ has remained a
leader in the implementation of inflation targeting. In particular, the RBNZ increasingly used the
inflation forecast as the intermediate monetary policy objective. In the current inflation targeting
literature, the term “inflation forecast targeting” (IFT) is often used synonymously with flexible

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inflation targeting. 5 In this framework, Figure 1. Dincer-Eichengreen Central Bank

the central bank communicates on how Transparency Index
it will achieve the inflation objective
through its forecasts and the monetary
policy setting embedded in the
forecast. Such a regime requires a high
degree of policy transparency, which
the RBNZ has maintained over time, as
measured, for example, by the Dincer-
Eichengreen index (Figure 1). In
particular, since 1997, the RBNZ has
been fully disclosing its macroeconomic
forecast, including the expected path of
the policy rate (Table 1).
Source: Dincer and Eichengreen (2014) and IMF staff calculations.

8. The evolution of inflation
targeting in New Zealand took place in the context of a broader evolution of global IT
practice. In the early stages, the RBNZ, like other IT central banks, focused primarily if not
exclusively on achieving price stability objectives. The lack of concern about output and employment
stability was based on the argument that, in most situations, “divine coincidence” was present
(monetary policy aimed at stabilizing inflation happens to also stabilize output). 6 But, over time,
experience suggested that paying little or no attention to output or employment was not optimal in
all situations. Depending on the nature of the shocks affecting the economy, monetary policy paying
attention to output stabilization might actually help in achieving price stability objectives in the
longer term. 7 Important examples are the case of large shocks generating a trade-off between
stabilizing inflation and resource utilization, or when policy tries to ensure a low probability of
hitting the zero lower bound on interest rates. 8 Clinton and others (2015) argue that central banks
following flexible inflation targeting frameworks also operate with a dual mandate, albeit the second
(output or employment) objectives are sometimes not explicitly formulated.
5 IFT is defined in Adrian and others (2018), among others. This paper uses the terms “flexible inflation targeting” and
IFT interchangeably. In this regime, the forecast is the intermediate target; the inflation objective is the ultimate
anchor. Moreover, the central bank’s inflation forecast is the intermediate target: it is used to communicate how the
central bank is managing the short-term output-inflation tradeoff (explicit or implicit dual-mandate) and it is based
on all available information and views about how the economy works. In a flexible inflation targeting regime the
emphasis is on uncertainty and “avoiding dark corners” (a prudent risk-management approach to policy formulation
and communications).
6 Among others, Rogoff (1985) and Walsh (1995) argue for a strong focus on price stability. Woodford (2003) argued
that a welfare-maximizing central bank should assign some, albeit a relatively small, weight to output stabilization
when forming policy. Blanchard and Galí (2007) showed that stabilizing inflation allows the central bank to
simultaneously stabilize welfare-relevant measures of economic activity, which is also known as the “divine
coincidence.”
7 For example, see Debortoli and others (2017).
8 For similar arguments, see Clinton and others (2015).

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Table 1. Established IFT Central Banks Endogenous Interest Rate Forecasts
Canada No, but communicate it with words

Chile No, but communicate it with words
Czech Republic Yes (since 2008)
New Zealand Yes (since 1997)
Norway Yes (since 2005)
Sweden Yes (since 2007)
United States Yes (since 2012)
Source: Clinton and others (2017).
Inflation Targeting and Economic Outcomes in New Zealand
9. Comparing outcomes between the strict and flexible inflation targeting regimes, both
inflation and output are now more stable. Figure 2 shows that inflation expectations, both in the
short and long term, were well-anchored quickly in the first period of inflation targeting in New
Zealand (under “strict inflation targeting”). Both the level and the variability of inflation were also
lower than before. But key real variables, output and employment, experienced increased volatility
(Table 2). With the transition to flexible inflation targeting, low inflation, both level and variability,
could be maintained, while the variability of GDP growth and employment also became more stable
(and the variance of the output gap remained the same). The nominal exchange rate also served as
a shock-absorber since 2002. In the case of well-functioning flexible inflation targeting, the nominal
exchange rate plays a significant stabilization role, especially for small open economies facing
significant commodity price shocks.
Figure 2. Inflation and Expected Inflation
Sources: Haver Analytics, and International Monetary Fund.

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Table 2. Macroeconomic Performance Under Different Monetary Regimes (1981-2017)

GDP growth Output gap* CPI inflation Unemployment
rate
(annual % change) (% of potential GDP) (annual % change) (%)
Average
Before Inflation Targeting (1981-1989) 2.4 -0.8 11.3 5.4
Strict Inflation Targeting (1990-1997) 2.8 -1.8 2.5 8.4
Flexible Inflation Targeting (1998-2017) 2.9 -0.2 2.0 5.3
Standard error
Before Inflation Targeting (1981-1989) 1.5 1.3 4.7 1.5
Strict Inflation Targeting (1990-1997) 2.8 2.0 1.7 1.8
Flexible Inflation Targeting (1998-2017) 1.5 2.0 1.1 1.1
Source: Haver Analytics, International Monetary Fund Spring 2018 World Economic Outlook.
10. New Zealand experienced mild output losses during the Global Financial Crisis (GFC).
Although the recovery after the GFC took longer than after other recessions, New Zealand’s output
loss was less severe than that in many other advanced economies (Figure 3). Part of the reason was
that well-anchored inflation expectations helped keep the ex-ante real interest rates low during the
height of the crisis and monetary easing thus helped to stabilize output. The Official Cash Rate
(OCR) did not reach its effective lower bound (Figure 4). The trough of the output gap after the GFC
was among the closest to zero in New Zealand, such that the mean output gap was less negative
compared to the euro area, Japan, and United States, for example (Table 3). While monetary policy
contributed to this favorable outcome, other factors also contributed, including strong aggregate
demand support from Asia, positive supply shocks (an acceleration of net migration filling in higher
skilled jobs), the fact that New Zealand did not experience direct shocks to its financial system or
trade financing, and favorable commodity price developments.
Figure 3. Output Gap in Selected Economies Figure 4. Official Cash Rate and Inflation*
(Percentage of potential GDP) and Output Gap
(Percentage point)
Source: International Monetary Fund, Spring 2018 World * Inflation Gap as measured by deviation from the 2 percent
Economic Outlook. target.
Source: Reserve Bank of New Zealand, Monetary Policy
Statement, May 2018.

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Table 3. Descriptive Statistics on Output Gaps (2009-2017)

Average Standard Minimum Maximum
Error
New Zealand -1.5 1.0 -2.5 0.1
Australia -0.8 0.3 -1.1 -0.1
Canada -0.4 1.3 -3.1 1.2
Euro Area -1.7 0.8 -2.8 -0.5
France -2.1 0.5 -2.8 -1.1
Germany -0.3 1.5 -3.9 1.1
Italy -2.6 1.3 -4.1 -0.5
Japan -3.2 1.9 -7.3 -0.8
Norway -0.7 0.6 -1.3 0.2
Sweden -1.3 1.7 -4.8 0.7
UK -1.5 1.1 -3.0 -0.1
US -1.8 1.7 -4.6 0.3
Source: International Monetary Fund, Spring 2018 World Economic Outlook, IMF staff estimates.
11. Recently, the main monetary policy challenge has been to deal with inflation being
below its target in an economy close to or at full employment. As many other countries, New
Zealand has, since the GFC, experienced a relatively long period of inflation remaining below its
target, the mid-point of the 1-3 percent target range. In part, the undershooting has been the result
of imported deflation, with tradable price deflation reflecting a long and weak global recovery after
the global financial crisis. Domestically, positive labor supply shocks from net migration inflows
contributed to high employment growth and larger than expected increases in potential output. 9 As
a result, economic slack decreased more slowly than expected by the RBNZ. Inflation, therefore,
remained weaker than expected. Moreover, in the absence of a domestic policy rate response, the
decline in equilibrium real interest rates worldwide (see Laubach and Williams, 2015 and Obstfeld
and others, 2016) would have also contributed to the tighter monetary conditions. Over time,
however, estimates of output gaps were revised, taking into account the persistent labor supply and
tradable deflation dynamics. Policy rates were lowered and the RBNZ has signaled the need for
monetary policy to remain accommodative for a considerable period of time.
C. Operationalization of the Dual Mandate
12. Despite the growing recognition that using monetary policy for stabilization is
beneficial, only two central banks have explicit dual mandates. 10 The two central banks with a
9 In addition, considering the very dynamic increase in house prices, monetary policy might have been reluctant to
ease further to safeguard financial stability. In other words, monetary policy, despite not being at the effective lower
bound, was in a situation where the risk of potential negative outcomes from further easing was deemed to be
significant.
10 Following U.S. practice, a joint price stability and employment mandate is often referred to as dual mandate. For
an overview of central bank mandates, see Reis (2013).

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Figure 5. Revisions to the Projections in the Monetary Policy Statements

Positive output gaps were revised down. Inflation was systematically below target.
Output gap (%) Headline inflation
Interest rate path was revised down.

Official Cash Rate
Source: RBNZ, Monetary Policy Statement, May 2018.
(legally) explicit dual-mandate central banks are the Fed in the United States and the Reserve Bank
of Australia.
13. In practice, monetary policy outcomes in countries with flexible inflation targeting are
similar, irrespective of whether the dual mandate is implicit or explicit. Flexible inflation
targeting countries (including New Zealand) have enjoyed policy and welfare outcomes that were
similar to those in countries where the central bank has an explicit dual mandate. The behavior of
two key indicators, inflation and output gap, suggests that there appears to be slight difference in
outcomes among flexible inflation targeting countries, regardless of whether the secondary
objective is implicit or explicit. Figures 6 and 7 illustrate this point. Figure 6 shows that if current
inflation was below the target, expected inflation was higher than or at the target (a slight
overshooting 3 year ahead) in the countries with an explicit dual mandate and in the countries with
a flexible inflation targeting regime. On the other hand, in countries that do not follow a flexible
inflation targeting regime or that do not have an explicit dual mandate (e.g., the euro area or Japan),
expectations were drifting. In this case, when economic slack was present and when current inflation

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was low, lower expected future inflation drove up real interest rates and induced an immediate real
appreciation in the currency. This further depressed output and lowered inflation in the future. In
flexible-inflation-targeting countries and explicit dual mandate countries this was not the case.
Markets expected that monetary policy would try to recover some of the output loss associated with
lower-than-target inflation, and inflation expectations remained stable. Figure 7 presents the loss
arising from a hypothetical welfare measure (with equal weight on the output gap and inflation ‘s
deviation from its target). 11 By this metric, New Zealand fared quite well in international comparison
as both inflation and output were stabilized to a considerable extent since 2012. Japan and the euro
area, both of which do not belong to the group of flexible-inflation-targeting countries had a worse
overall outcome than most flexible-inflation-targeting countries.
Figure 6. Anchoring of Inflation Expectations (2015-2018)

New Zealand vs. other IFT or explicit dual mandate New Zealand vs. countries without IFT or explicit
countries dual mandate
Source: Consensus Economics, IMF staff estimates.
14. A numerical employment objective could unduly constrain the conduct of monetary
policy, constraining and straining the RBNZ’s credibility. The behavior of inflation expectations
and the welfare losses in New Zealand (Figures 6 and 7) are consistent with the claims of McDermott
(2018) that, after the late 1990s, the RBNZ became flexible and secondary considerations were
added (avoiding unnecessary instability in output, interest rate and exchange rates). Hence, a more
explicit dual mandate would recognize the reality of the current IFT regime, as the RBNZ already
considers output gaps in its policy decisions. Assuming that monetary policy is neutral in the long
term, any numerical objective that is inconsistent with the economy’s actual natural rate of
unemployment or level of potential output would create an unachievable goal for the central bank.
This latter could give rise to time-inconsistent policies (“inflation bias”) and in turn, decrease the
effectiveness and the credibility of the monetary regime. In addition, as demonstrated earlier, there
is uncertainty about the extent of economic slack (as unexpected shocks arose for example during
2012-2016) and, with sizeable supply shocks, it is also time varying.
11A simple quadratic loss function was used to approximate welfare. The loss function as defined as Loss = Output
Gap2 + Inflation Gap2+0.5*change in the official interest rate2, following Al-Mashat and others (2018).

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15. The March 2018 PTA should set the model for the formulation of the employment
objective. The forthcoming amendment to the Reserve Bank Act and the setting of monetary policy
objectives should follow the current PTA, consistent with the Cabinet Paper (2018) and the
Independent Expert Advisory Panel (2018). The Fed and the RBA, the two other dual mandate central
banks, also followed the route of a qualitative employment objective (see Box 1).
Figure 7. Illustrative Loss Functions* (2012-2018)
* Loss function as defined as Loss = Output Gap2 + Inflation Gap2+0.5*Change in official interest rate2
Source: Staff estimatates
16. The RBNZ’s policy communication will now require greater emphasis on the
assessment of maximum sustainable employment. The Fed publishes governors’ estimates of the
non-accelerating inflation rate of unemployment (NAIRU). The RBNZ has traditionally been reluctant
to publish its assessment of the NAIRU, given the wide swings in the unemployment rate, and has
instead focused on potential output and the output gap to assess the state of the real economy. But

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the Monetary Policy Statement of May 2018 (RBNZ, 2018b) contains a thorough assessment on how
the RBNZ sees the evolution of “maximum sustainable employment” going forward.
Box 1. The Specification of the Output/Employment Goal for the Fed and the RBA
The legal text for the RBA says that “… the Reserve Bank Board, will best contribute to: (a) the stability of the
currency of Australia; (b) the maintenance of full employment in Australia; and (c) the economic prosperity and
welfare of the people of Australia.”1 The RBA, however, is not very explicit about the output/employment
goal. In explaining policy, it makes only an implicit judgment on how the maintenance of full employment
will be achieved. “The inflation target is defined as a medium-term average rather than as a rate (or band of
rates) that must be held at all times. This formulation allows for the inevitable uncertainties that are involved
in forecasting, and lags in the effects of monetary policy on the economy. […] This approach allows a role for
monetary policy in dampening the fluctuations in output over the course of the cycle.”
The Fed publishes its assessment on the numerical (though possibly time-variant) normal rate of
unemployment and pursues a “balanced approach” in forming policy. The Fed’s statute: “The Board of
Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long-run
growth of the monetary and credit aggregates commensurate with the economy's long-run potential to
increase production, so as to promote effectively the goals of maximum employment, stable prices, and
moderate long-term interest rates.”2 When it comes to actual policy “[t]he Committee judges that inflation at
the rate of 2 percent … [and that].. [t]he maximum level of employment is largely determined by nonmonetary
factors … [which] may change over time and may not be directly measurable. As a result, the FOMC does not
specify a fixed goal for maximum employment. […] Committee participants' estimates of the longer-run
normal rate of unemployment ranged from 4.3 to 5.0 percent and had a median value of 4.6 percent.”3
1
See Reserve Bank of Australia (2018a).
2
See Federal Reserve System (2018a).
3
See Federal Reserve System (2018b).
D. Conclusion
17. The Phase One of the Review of the Reserve Bank Act can be regarded as a next step in
the gradual evolution of inflation targeting in New Zealand. The new PTA, with its qualitative
description of the employment objective, can be regarded as a refinement in the current practice of
inflation targeting. The flexible inflation targeting regime was successful in terms of stabilizing
output and inflation while maintaining price stability. Recent episodes of inflation undershooting the
target serve as an example of uncertainty on the real-time assessment of slack in the economy. The
explicit dual mandate will require some changes in the communication of the central bank, including
on maximum sustainable employment.

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References
Al-Mashat, R., K. Clinton, B. Hunt, Z. Jakab, D. Laxton, H. Wang, and J. Yao, 2018, “Monetary Policy in
the New Mediocre,” IMF Working Paper, forthcoming.
Adrian, T., Laxton, D. and Obstfeld, M. (eds.), 2018, Advancing the Frontiers of Monetary Policy,
Washington, D.C.: International Monetary Fund, 2018.
Armstrong, J., 2015, “The Reserve Bank of New Zealand’s Output Gap Indicator Suite and its Real-
time Properties,” RBNZ Analytical Notes, AN2015/08.
Blanchard, O., and J. Galí, 2007, “Real Wage Rigidities and the New Keynesian Model,” Journal of
Money, Credit, and Banking 39(1): 35-65.
Cabinet Paper, 2018, “Modernising New Zealand’s Monetary Policy Framework: Phase One,” Cabinet
paper, accessed at https://treasury.govt.nz/sites/default/files/2018-04/rbnz-rev-cabinet-
paper-phase1.pdf on 31 May, 2018.
Clinton, K., C. Freedman, M. Juillard, O. Kamenik, D. Laxton, and H. Wang, 2015, “Inflation-Forecast
Targeting: Applying the Principle of Transparency," IMF Working Paper WP/15/132.
Clinton, K., T. Hlédik, T. Holub, D. Laxton, and H. Wang, 2017, “Czech Magic: Implementing Inflation-
Forecast Targeting at the CNB,” IMF Working Paper No. 17/21.
Debortoli, D., J. Kim, J. Lindé, and C. Nunes, 2017, “Designing a Simple Loss Function for Central
Banks: Does a Dual Mandate Make Sense?” IMF Working Paper WP/17/164.
Dincer, N. and B. Eichengreen, 2014, “Central Bank Transparency and Independence: Updates and
New Measures,” International Journal of Central Banking 10(1): 189-259.
Federal Reserve System, 2018a, “Section 2a. Monetary Policy Objectives,” accessed at
https://www.federalreserve.gov/aboutthefed/section2a.htm on 31 May 2018, referring to 12
USC 225a. As added by act of November 16, 1977 (91 Stat. 1387) and amended by acts of
October 27, 1978 (92 Stat. 1897); Aug. 23, 1988 (102 Stat. 1375); and Dec. 27, 2000 (114 Stat.
3028).
__________, 2018b, “What are the Federal Reserve's Objectives in Conducting Monetary Policy?”
accessed at https://www.federalreserve.gov/faqs/money_12848.htm on 31 May 2018.
Independent Expert Advisory Panel, 2018, “Review of the Reserve Bank Act,” accessed at
https://treasury.govt.nz/sites/default/files/2018-04/rbnz-rev-panel-report-phase1.pdf on 31
May 2018.
Laubach, T. and J. C. Williams, 2015, “Measuring the Natural Rate of Interest Redux,” Federal Reserve
Bank of San Francisco Working Paper 2015-16.

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McDermott, J., 2018, “Inflation Targeting in New Zealand: An Experience in Evolution,” Speech
delivered to the Reserve Bank of Australia Conference on Central Bank Frameworks, in
Sydney, 12 April 2018.
Obstfeld, M., K. Clinton, O. Kamenik, D. Laxton, Y. Ustyugova, and H. Wang 2016, “How to Improve
Inflation Targeting in Canada,” IMF Working Paper No. 16/192.
Reis, 2013, “Central Bank Design,” presented at the conference “The First 100 Years of the Federal
Reserve,” NBER Working Paper 19187.
Reserve Bank of Australia, 2018, “Our Role,” accessed at https://www.rba.gov.au/about-rba/our-

role.html, on 31 May 2018.
Reserve Bank of New Zealand, 2018a, “New PTA Requires Reserve Bank to Consider Employment
Alongside Price Stability Mandate,” accessed at
https://www.rbnz.govt.nz/news/2018/03/new-pta-requires-reserve-bank-to-consider-
employment-alongside-price-stability-mandate on 31 May 2018.
__________, 2018b, Monetary Policy Statement, May 2018.
Riksbank, 2017, “Basis for Decision: Target Variable and Variation Band,” accessed at
https://www.riksbank.se/globalassets/media/nyheter--
pressmeddelanden/pressmeddelanden/2017/bilagor/remis_beslutsunderlag_remiss_170516_
eng.pdf, on 11 May 2017.
Rogoff, K., 1985, “The Optimal Degree of Commitment to an Intermediate Monetary Target,”
Quarterly Journal of Economics 100(4): 1169-89.
Walsh, C., 2005, “Endogenous Objectives and the Evaluation of Targeting Rules for Monetary Policy,”
Journal of Monetary Economics 52: 889-911.
Woodford, M., 2003, Interest and Prices, Princeton: Princeton University Press.

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HOUSING AFFORDABILITY IN NEW ZEALAND AND

POLICY RESPONSE1
A. Introduction
1. House prices in New Zealand have risen rapidly since early 2000s. After the housing
boom of 2001-07, house prices took a short pause after the global financial crisis (GFC), and
resumed a rapid growth path from 2011. During 2011-16, house prices rose by 54 percent
(60 percent) in real (nominal) terms or an average 9 percent (10 percent) in real (nominal) terms
annually. The surge in house prices in New Zealand has mostly surpassed other advanced
economies, in part because it has not experienced a major house price correction.
2. The rapid house price growth has resulted in skewed increases in income and rent
ratios. These house price valuation metrics put New Zealand above other OECD countries, after
large increases in price-to-income and price-to-rent ratios since 2000.
3. The persistent rise in house prices is due to a combination of demand-side factors and
stickiness in the housing supply response. Demand for home ownership rises with household
income, including upgrades to larger and higher quality houses. The low interest rate environment
since the GFC has increased household loan servicing capacity. Combined with the relative ease of
obtaining credit as banks have competed for mortgage market shares, low interest rates have
boosted growth in housing loans and supported higher house prices. Population has grown rapidly
since 2000, driven partly by two waves of strong net immigration. In the most recent surge from
2013-17, almost half of the population increase was recorded in Auckland. With this geographical
concentration of the population increase and the associated demand for housing, the price impact
of the constrained housing supply response has been particularly large. This is despite residential
1
Prepared by Yu Ching Wong (APD). The chapter benefited from valuable comments by the Treasury of New Zealand
and participants at a roundtable discussion including members of the Treasury, the Ministry of Business, Innovation
and Employment, and the Reserve Bank of New Zealand.

NEW ZEALAND
investment increasing from 4 percent to 8 percent of GDP during 2011-17, making up nearly a third
of all gross fixed capital formation in 2017. In other words, inelastic supply has amplified the impact
of the demand shock.
4. House price increases became more pronounced around 2015-16. Staff’s updated estimate
suggested that real house prices are around 20-25 percent higher than the level consistent with
economic fundamentals reflecting demand underpinned by affordability (house price to income),
real disposable income, working-age population, equity prices, and the level of short and long-term
interest rates (Nyberg, 2016). [A large deviation from price fundamentals expose the economy to a
higher risk as a disruptive house price correction could put the banking system, with more than
60 percent of credit exposed to residential mortgages, under severe pressure. The resulting credit
contraction would further amplify the impact of the downturn on domestic economic activity and
the banking sector.
5. The housing market has cooled recently, but household debt remains elevated. House
prices appeared to have peaked in 2016. Household credit growth has moderated due in part to the
impact of loan-to value ratio (LVR) restrictions, banks’ tightening of lending standards and
marginally higher mortgage rates since early 2017 (Box 1). Nevertheless, the high cost of housing
drove household debt further to 168 percent of household disposable income in 2017.
6. Housing affordability remains a key concern. For New Zealander, the standard aspiration
or the Kiwi dream is centered on the acquisition of a family home. However, as the impact of high
house prices persists, affordability has become a political hot-button issue. In response, the recently-
elected new government is putting in place a comprehensive program to improve the affordability
of housing. Against this background, the rest of this paper reviews how much housing affordability
has deteriorated and summarizes recent policy measures to support housing affordability. It also
discusses the appropriateness of the policy response and provides suggestions for refinement.

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Box 1. Demand Impact of Macroprudential Policy

Financing constraints from loan-to-value ratios (LVRs) restrictions have reduced housing demand
temporarily and thereby contributed to slowing house price growth. After three rounds of tightening of
LVRs restrictions in October 2013, November 2015 and October 2016, the share of outstanding residential
mortgages with LVR above 80 percent has declined to under 8 percent in September 2017, from 21 percent
in September 2013 before the imposition of nay LVR restrictions. Bank and household balance sheets have
thereby become more resilient with a lower share of loans with high LVRs. The RBNZ relaxed the LVR
restrictions marginally as of January 1, 2018, raising for each bank’s new mortgage lending to (i) owner
occupiers at LVRs of more than 80 percent to no more than 15 percent from previously 10 percent; and (ii)
residential property investors at LVRs of more than 65 percent from previously 60 percent while keeping the
cap at no more than 5 percent. Going forward, it will be important for the banks to maintain high lending
standards, including robust assessment of debt serviceability with rising mortgage rates. The
macroprudential toolkit could be strengthened by adding a debt-to-income (DTI) or debt-service-to-income
(DSTI) instrument, which in event of a future decrease in interest rates, would just increase housing demand,
unless there is the ability to curb it through an additional instrument.
Macroprudential policy is nonetheless not the instrument to address housing affordability.

Macroprudential policies aim to manage financial system risk by increasing the resilience of bank balance
sheets to a potential shock; and by dampening a credit and asset price cycle on the upswing to reduce the
risk and severity of the eventual downturn. In this context, there is a trade-off between macro-prudential
policy measures that might make credit less accessible but should help to make house prices more
affordable in the longer term. However, as macroprudential policy is not for enhancing social equity, the
implications on housing affordability are just positive side effects, not the intended objective.
B. How Much Has Housing Affordability Declined?
7. Housing affordability has different implications for renters, potential home-buyers

and existing home owners. The concept probably has evolved from “one week’s pay for one
month’s rent” (Hulchanski, 1995), common benchmarks of affordability are expenditures on housing
(mortgage repayment, rents) to income ratios in the range of 25-40 percent, focusing more on the
lowest 40 percent of income earners or households. Factors that contribute to housing affordability
would often include income (affected by labor market condition), house prices and rents (reflecting
supply constraints), and interest rates and mortgage term (indicating costs of borrowing). MBIE
(2017) defines housing affordability as being able to meet housing costs (either of owning or
renting) out of income without having an adverse impact on the ability to afford the basic living
requirements, recognizing that determining affordability depends on each household’s
circumstances and expectations of what qualifies as a socially accepted standard of living. Given
heterogeneity in the level of affordability, there are inherent difficulties in measuring housing
affordability with simple averages across house prices and household incomes.
8. Housing affordability in general has not deteriorated much because of the large
decline in interest rates since the GFC. The decline in residential mortgage rates (floating rate for
new customers) from an average 8.7 percent in 2000-08 to 6.1 percent in 2009-15, and further to
5.7 percent since 2016 against the global low interest rates environment has largely offset the
impact of higher house prices on mortgage costs. The remaining of this paragraph summarizes
some standard affordability indicators, with the appropriate caveats.

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• Household by tenure. Home ownership has been declining from more than 70 percent during
1990-97 to 63 percent of the total households in June 2017. 2 At a broad level, a decline in home
ownership could indicate a deterioration of housing affordability, assuming there are no
underlying changes in ownership preference. However, the share of owner and tenant
households vary widely across countries while in most countries more than two out of three
households own their dwelling (OECD, 2016). On the other hand, in New Zealand, the share of
dwelling not owned by its primary resident is higher in lower income quantiles relative to higher
quantiles, which is consistent with the global pattern that a household’s likelihood of home
ownership increases with income.
• House price-to-income ratio. The

nationwide house price-to-income ratio
rose rapidly to about 7 from below 3 in the
early 1990s, with a widening wedge
between Auckland and the rest of New
Zealand since 2013. While this indicator is
simple to compile and widely used for
cross-country and time series comparison, it
does not reflect the level of housing related
expenses such as the prevailing interest rate
(see further analysis below).
• Housing cost indicators. Housing cost indicators suggest that affordability in general has not
changed much over the last decade, with average housing costs remaining at below 20 percent
of household income. The ratio in 2016 marginally exceeded the previous peak in 2011 but has
since declined in 2017, with the national average at 15.8 percent and Auckland at 17 percent. In
terms of the distribution at different cost thresholds, 71 percent of all households have housing
2
Stats NZ estimates of households and dwellings by tenure show that the number of dwellings either
rented or provided rent-free to occupants grew almost 23 percent between 2007 and 2017, while the
total number of dwellings grew only 11 percent (MBIE, 2018).

NEW ZEALAND
costs at less than 25 percent of total household income in 2017 at the national level, compared
with 11 percent of households that have housing costs at more than 40 percent of total
household income. The mortgage interest to principal repayment ratio declined to 1.3 in 2017
from 2.8 in 2008. Historically low interest rates level has helped keep total housing costs largely
unchanged despite higher principal repayment required for larger housing loan.
9. Some segments of the population however suffered a larger deterioration in housing

affordability. Lower income groups are naturally more adversely affected by declining housing
affordability given their smaller income buffer net of living expenses. This includes renters,
accounting for a higher share in lower income groups, who are exposed to higher rents in private
rental markets if the impact of housing shortages pushes up rent. As for first home buyers,
increasing house prices is a growing barrier delaying their entry into home ownership, since it takes
longer to save for a mortgage down payment and requires a higher level of debt servicing capacity.
even with low interest rates.
• Lower income households. Using an outgoing-expenditure-to-income ratio (OTI) of 30

percent as a benchmark for high OTIs, 29 percent of households had high OTIs in 2016,
compared to only one in five in the early 1990s. Unsurprisingly, 39 percent of households in
the bottom two income quantiles had high OTIs in 2016, considerably higher than 22 percent
for the second highest and 15 percent for the highest income quantile. While affordability has
been broadly unchanged over 2007-16, households in the second-lowest income quantile
experienced a considerable increase in their OITs from 29 percent in 2007.
• First-home buyers and renters. A new Housing Affordability Measure (HAM) compiled by the
MBIE examines household incomes, subtracting the cost of buying or renting and compares
that to a 2013 benchmark to track affordability over time. 3 The share of potential first home-
3
Income after housing costs for the average New Zealand household is NZ$662 per week for a one-person
household. This amount is adjusted for household size.

NEW ZEALAND
buyer households with below average income after housing costs increased to 82 percent in
2016Q1 in Auckland, compared to 77 percent at the national level. In contrast, the share of
renter households with below average income net of housing costs decreased to 60 percent in
2016Q1 from 66 percent in 2011Q2. For Auckland, HAM suggested a similar declining trend for
renter households to 56 percent in 2016Q1 from 61 percent in 2011Q2. Taking the above two
HAMs together, the outlook does look dim if an existing renter were to also save to purchase a
home (see further discussion in Box 2). In this regard, the HAM could be usefully extended to
measure the number of years needed for a potential first home-buyer to save for a mortgage
down payment.
10. The central group subject to the affordability problem is new entrants to the labor
market with little of the savings needed for home ownership. Rising house prices pose
increasing difficulties for first-time home buyer as the national median house price rose to
NZ$550,000 in December 2017 from NZ$520,000 a year ago, while Auckland's median rose to
NZ$870,000 from NZ$855,000 over the same period. This translates into a house price-to-income
ratio of 6.4 for the national median and 6.7 for Auckland. To estimate housing affordability for a
first-time home buyer, a 20 percent down payment is assumed with associated monthly repayment
costs of a 5-year fixed rate mortgage as of April 2018 on a 30-year annuity payment, to determine
the debt service-to-income (DSTI) ratio. Also assumed is a maximum allowable DSTI at 30 percent to
derive a corresponding affordable house price. The results in Table 1 illustrate that at existing
median house price at the national level and in Auckland, DSTI ratios would rise to 37 percent and
56 percent, respectively (Scenario A). Alternatively, if the home buyer has an objective to achieve a
more comfortable DSTI ratio at 30 percent, the implied affordable median house price level would
be NZ$451,000 (18 percent lower than actual) at the national level and NZ$466,000 (46 percent
lower than actual) in Auckland (Scenario B). The illustration also shows that with the higher DSTI, it
will take 4.2 years (4.5 years) at the national level (in Auckland) to save for a 20 percent mortgage

NEW ZEALAND
down payment to purchase a median price house assuming a relatively high saving rate at
30 percent of household income. 4
Table 1. Illustrative Housing Affordability Scenario
11. Overall housing affordability in New Zealand is broadly comparable with trends in
other advanced economies facing similar challenges from housing booms. For Canada, housing
affordability has deteriorated after an improvement post-GFC, with the average mortgage payment
reaching 35 percent of average income in 2017. In Australia, mortgage repayments in capital cities
have crept up since 2013, accounting for 42.5 percent of average earnings in 2017 while the steepest
increase was in Sydney where mortgage repayments used up close to 60 percent of income. These
levels are considerably higher than the 30 percent threshold in Australia which demarcates
affordable conditions for an average first home buyer.
4
MBIE (2018) compared average wages of employees and median house prices to calculate the number of years at
this wage required to purchase the median priced house. It showed that to the extent to which Auckland’s house
prices have risen much faster than wages – it would require a rise from around ten years’ wages in early 2012 to 16
years in 2016 although with a slight easing more recently.

NEW ZEALAND
Box 2. Private Rental Market
Rental yield in New Zealand, as in most advanced economies, has been declining since the 1990s.
Rental yield—the rent a property could potentially generate in a year expressed as a percentage of its
purchase price—has fallen to 2.5-3.5 percent in 2017 from 6-7 percent in the early 1990s as house prices
have risen faster than rents (RBNZ 2018). Low and falling yield could indicate that residential investors are
buying properties mainly because of expected capital gains that far outstrip rental income.
The cost of renting is expected to pick up as the housing market rebalances. Private rents, as reported
by MBIE based on mean rents (from bonds lodged with Tenancy Services), rose on average just below 5
percent annually in the last 5 years, largely consistent with inflation and growth in earnings, as opposed to
house price inflation. The relative stability of rents while house prices were rising more rapidly has allowed
the rental market to act as a “safety valve’ for households that cannot afford to own a house. However, this
apparent disconnect between house prices and the rents may disappear when higher demand for rental
housing, in part as home ownership becomes less affordable, begin to push up private market rents.
Moreover, the recent rapid increase in short-term rentals, particularly in Auckland, along with the tourism
boom may also reduce rental availability and push up rents.
A shortage of affordable housing for private rental or ownership also poses challenges for social
housing. Government intervention is in general needed more on the weaker end of the housing continuum
starting with emergency and transitional housing, social housing, and subsidized private rental, and much
less in private rental and ownership markets (MBIE 2017). Housing New Zealand manages more than 64,500
social housing units (June/August 2017) nationwide but the stock is clearly not sufficient to meet the
demand for lower income families. As more low-income households may have to rent from the private rental
market, a surge in private rents would put many into precarious situations.
Rental Yields
Source: RBNZ Macro-Prudential Chartpack, March 2018.
C. Supply-Side Policy Response to Improve Housing Affordability
12. Creating responsive housing supply is key to improve housing market imbalances. The
authorities estimated the nationwide housing shortfall at more than 70,000 homes in 2017, of which
the shortage in Auckland accounts for around 45,000 units. Relieving chronic housing supply
constraints would require policy action to address bottlenecks including land markets, infrastructure,
and the construction sector. Increasing land supply and more efficient use of land through
improving planning rules and zoning would lower cost of housing. For instance, the new Auckland
Unitary Plan appears to have freed up significantly development capacity over previous plans, over a
larger geographic area. Infrastructure to support housing development would need to overcome

NEW ZEALAND
often financing constraints faced by local governments. The significant price mark-up to
construction costs suggests that housing prices would be lower in more competitive markets.
Improving the capacity and competition in the construction sector would help to improve the price
and quality of housing.
13. Direct government intervention through the KiwiBuild program to supply affordable
housing. The government’s new KiwiBuild program announced in late 2017 aims to build 100,000
affordable housing units over 10 years to address the housing shortfall. One-half of the KiwiBuild
housing units are planned for Auckland where the housing shortage is more severe than the rest of
the nation. With an initial financing of NZ$2 billion, the program is expected to be financed
subsequently through sales of completed houses to first-time home buyers. While details of the
KiwiBuild program are being planned and rolled out, at present, KiwiBuild dwellings (one-bedroom
and outside of Auckland and Queenstown) will be priced at or below NZ$500,000. For the starting
first three years, the bulk of the targeted 16,000 units will be constructed as part of private
development underwritten by the KiwiBuild program. If it is as effectively implemented as planned,
the increase supply of housing from the KiwiBuild program would help to close the housing gap
based on current assumptions and forecasts for underlying demand.
14. The KiwiBuild program should aim to promote cost and price efficiency while limiting
market distortions. The main rationale for the government’s direct involvement in an affordable
private housing program should be to focus on creating the certainty needed to redirect builders’
incentives (including easier bank funding under
guaranteed prices for KiwiBuild homes), and
bringing necessary reforms in the construction
sector. For instance, the adoption of new
building technology would promote more
cost-effective construction. Similarly, easing
land use regulation would help to reduce the
large price-cost markups (Lees, 2017). Given
the current labor supply constraint in the
construction sector, the KiwiBuild program
would also require a smooth implementation
of the announced special visa program to
augment skilled labor. Overall, the proposed
increase in homes under the program should
not crowd out private residential construction by adding to supply side constraints.
15. The effective delivery of the KiwiBuild program will depend critically on harnessing
complementary reforms. These should include increasing land supply, improving planning and
zoning, and increasing local governments’ financing and capacity for supporting infrastructure. At
the same time, the government’s Urban Growth Agenda’s aims to enhance land market competition,
which if successfully implemented will address over-regulation, under-funding and fragmented

NEW ZEALAND
planning. Together the two, should contribute to building enough homes and infrastructure to
support the population.
D. Demand-Side Policy Response to Housing Imbalances
16. Foreign buyers appear to have played a minor role in New Zealand’s residential real
estate markets recently. Similar to other advanced economies with favorable investment climate,
global capital inflows appeared to have played an increasingly important role in augmenting
housing demand in New Zealand. However, the extent to which non-resident investors have
impacted quantity and price pressures are difficult to quantify due to the paucity of data. Property
transfer and tax residency data collected under the Land Transfer Amendment Act from Oct 1, 2015
provide limited data in capturing foreign investors’ share in the real estate market. Based on these
data, about 3 percent of all buyers nationwide and 5 percent of buyers in Auckland have overseas
tax residency in 2017 (Table 2). The share of overseas tax resident buyers appears to have increased
from around 1 percent in 2015 when this set of data first became available. 5
Table 2. Tax Residency of Buyer
17. A ban of residential real estate purchases by nonresidents is therefore unlikely to

significantly improve housing affordability. The draft amendment to the Overseas Investment Act
currently under the parliament’s consideration aims to restrict non-residents’ purchase of existing
residential properties by bringing all residential land under the Overseas Investment Act's definition
of "sensitive land” which requires approval for purchases by non-residents. The proposed screening
regime allows overseas persons to obtain consent to acquire residential land where they are
committed to reside, and become tax resident, in New Zealand; where their investment will increase
housing supply; or where they will develop the land for other purposes (such as commercial
premises). However, this ban on foreign home ownership could discourage potential foreign direct
5 Further, based on more detailed data collected since Dec 2016, in 82 percent of all property transfers, one or more
buyers were citizens or residents. Transfers in which none of the buyers being citizens or residents accounted for
2 percent (either at least one buyer had either a student or work visa or had immediate family with New Zealand
citizenship/residency/work or student visa), whereas transfers which buyers are represented by corporate or business
entities accounted for 16 percent. For transactions in Auckland, the share of transfers which buyers are not citizens or
residents is higher at around 4 percent and transfers involving buyers that are corporate or business entities is about
20 percent.

NEW ZEALAND
investment that could help build more houses. The broad housing policy agenda consisting of
supply initiatives including the KiwiBuild program and reducing tax incentives (discussed below), if
fully implemented, would address most of the potential problems associated with foreign buyers
more effectively and on a non-discriminatory basis.
18. Tax incentives have favored investments in residential housing. Property investors
accounted for slightly above 35 percent of total purchases during 2014-16, before declining
marginally to below 35 percent in 2017, while the share of first home buyers has been largely stable
at around 20-22 percent during 2013-17. 6 At the same time, tax incentives might have accentuated
the house price increase as they affect an investor’s demand response to a price or yield shock.
Therefore, reducing the preferential treatment for investment in real estate would reduce incentives
to buy real estate as an investment product, and reduce demand and supply imbalances in the
housing sector.
19. Redirecting savings from housing to other investments to reduce housing demand
could also help affordability. To dampen property speculation, the bright-line test on residential
property sales introduced in October 1, 2015 had its threshold extended to five years from two
years. Any residential properties other than main home acquired after March 29, 2018 will be subject
to tax if disposed of within five years of acquisition. The government has also proposed to limit
negative gearing from rental properties, such that the deductibility of net losses from property
investment from other taxable income would be eliminated. Further, a Tax Working Group is
considering possible additional reform, including a broader capital gains tax on housing investment
(while still excluding primary residences) and possibly a land tax reform (also excluding primary
residences). However, ad valorem land tax for local governments could be introduced to secure
infrastructure funding to support housing development, as user fees only cover new developments
which do not meet the needs in existing neighborhoods.
E. Summary and Conclusions
20. The housing market is cooling but managing housing-related risks remain challenging.
Rising house prices were associated with rapid household credit growth through 2016. Given the
slower rise in income, house price-to-income ratios reached unprecedented levels, especially in
Auckland where the surge in house prices has been stronger. Household credit growth has
moderated in 2017 while household debt continued to rise from already high levels. Given the
underlying shortages in housing supply, the moderation in house prices is expected to be slow.
21. Affordability concerns have also become more pressing, especially for first-time home
buyers. The deterioration in housing affordability because of high house prices as measured by
housing cost to income has been partially offset by lower interest rates. Lower income groups
remain more adversely affected by declining housing affordability. Rising house prices pose
increasing difficulties for first-time home buyers entering the home market as it increases the length
6
RBNZ, 2018 Macroprudential Chart Pack, Chart 5D, March 2018.

NEW ZEALAND
of time needed to save for a mortgage down payment regardless of the level of interest rates, and
lead to higher debt servicing requirements as they need to have a larger mortgage than in the past.
22. The housing policy agenda is ambitious and appropriately focuses on closing key gaps
on the supply side and in the tax system. Housing supply shortfalls have contributed to the run-
up in house prices, reflecting supply constraints amid strong demand fundamentals, including rising
net migration, lower interest rates, and stronger income growth. While demand-side drivers have
stabilized, they remain robust, and improved housing affordability requires eliminating supply
bottlenecks. Supply and demand sides reforms are complementary, and the success of the housing
policy agenda will depend on well-coordinated progress on all fronts.
23. Lastly, improving the availability of housing affordability and other related statistical
data is important. Further effort to compile and regularly release key housing related indicators
such as house prices, housing costs, housing ownership and affordability measures would help to
enhance analysis and inform policy decisions.

NEW ZEALAND
References
A. Johnson, P. Howden-Chapman and S. Eaqub, 2018, A Stock Take of New Zealand Housing—
February 2018, Ministry of Business, Innovation and Employment (MBIE).
Nyberg, D., 2016, “House Prices, Household Debt, and Financial Stability Risks in New Zealand,” IMF
Selected Issues Paper, IMF Country Report No. 16/40.
Hulchanski, J., 1995, “The Concept of Housing Affordability: Six Contemporary Uses of the Housing
Expenditure-to-Income Ratio,” Journal of Housing Studies 10(4): 471-491.
Lees, K., 2017, “Quantifying the Impact of Land Use Regulation: Evidence from New Zealand,” Sense
Partners, report for Superu, Ministerial Social Sector Research Fund, June 2017.
M. Robinson, G. Scobie, and B. Hallinan, 2006, “Affordability of Housing: Concepts, Measurement

and Evidence,” Working Paper 06/03, The Treasury.
MBIE, 2017, Briefing for the Incoming Minister of Housing & Development, October 25, New Zealand
Government.
OECD, 2016, Affordability Housing Database.
Productivity Commission, 2012, Housing Affordability Inquiry, March 2012.
RBNZ, 2013, “Macro-prudential policy and the New Zealand Housing Market,” speech by Mr. Grant
Spencer, Deputy Governor and Head of Financial Stability of the Reserve Bank of New
Zealand, to the Business NZ Council, Wellington, New Zealand, 27 June 2013.

NEW ZEALAND
PRODUCTIVITY AND PROFITABILITY IN NEW

ZEALAND: THE ROLE OF LEVERAGE, R&D, AND
INVESTMENT1
A. Introduction
1. New Zealand’s productivity growth has been relatively low compared to other
advanced economies despite pioneering structural reforms. This is puzzling because New
Zealand has been a front-runner of structural reforms, including state-owned enterprise reforms,
transparent institutions, strong property rights, and others. A widely accepted explanation of the
puzzle has been New Zealand’s geographical remoteness and its small, insular market, which have
led to limited technological diffusion from global supply chains and less incentives for innovation
owing to small size of domestic market and firms (McCann 2009).
2. This paper analyzes New Zealand’s recent productivity performance from a firm-level
perspective, focusing on the role of corporate leverage. A growing number of empirical studies
has tried to find evidence on productivity enablers and innovation enhancers in New Zealand. The
focus has been on productivity spillovers from foreign direct investment (Doan and others 2015), the
size of firms (Hong and others 2016), agglomeration effects (Maré and Graham 2013), intangible
investment (Chappell and Jaffe 2018), exports (Fabling and Sanderson 2013), and research and
development (R&D) grants (Le and Jaffe 2017). So far, the literature has not focused on the role of
firms’ capital structure in the context of productivity, except Smith and others (2012) who finds long-
term debt is negatively associated with profitability of publicly listed firms. Against this backdrop,
this paper studies the recent productivity performance of New Zealand firms, focusing on the role of
leverage. The analysis draws on firm level data from the Orbis database. The Orbis database covers
both listed and unlisted private companies. It provides financial data, including balance sheet and
profit and loss account. However, the data sample is unbalanced in the time dimension, as New
Zealand firm representation in Orbis prior to the mid-2000s is scant.
3. The firm performance in New Zealand shows a general tendency toward stronger firm
profitability after the Global Financial Crisis (GFC). New Zealand firms generally reduced leverage
and capital investment after the GFC. At the industry level, there is some evidence that credit and
investment have shifted toward high productivity sectors, indicating greater scrutiny on firm
performance for credit extension after the GFC. Furthermore, R&D expenses are positively correlated
with profitability in firms that are at the productivity frontier, but not in other firms. This implies a
need for increasing the R&D capability of non-frontier firms. Also, low leveraged-firms spend more
on R&D.
1
Prepared by Ryota Nakatani (APD). The author thanks seminar participants at the IMF Article IV Consultation
Mission Seminar held at the New Zealand Treasury in Wellington and the Asia and Pacific Department Discussion
Forum held at the IMF in Washington, D.C. for comments and feedback.

NEW ZEALAND
B. Analysis
4. The paper analyzes firm productivity using two proxy performance measures.
Unfortunately, the Orbis database does not allow for the calculation of a sufficiently large panel data
set of firm-level productivity. The paper therefore uses other firm performance measures.
Specifically, it uses two profitability measures: profit margins (profits as a percent of sales) and the
return on assets (ROA). These measures have been used elsewhere as proxy measures for
productivity. Indeed, the relationship between productivity growth and average values for the
profitability measures across industries suggests some positive correlation (Figure 1). In New
Zealand, the multifactor productivities of information, transportation, agriculture, wholesale and
retail, and real estate industries grew strongly over the sample period. Meanwhile, ROAs of
information, transportation, wholesale and retail, and real estate industries are also relatively high.
Although ROA of agricultural industry is not so high in Orbis data, its profit margin is high. In
contrast, productivity growth in manufacturing, construction and utilities industries has been near
zero or negative, and their ROAs and profit margins are also lower.
Figure 1. Productivity and Profitability
Notes: Productivity growth is sectoral data. ROA and profit margin are based on firm-level data.
Source: Statistics New Zealand; Orbis; and IMF staff calculations.
5. Average ROA and profit margins increased after a drop during the GFC. Figure 2 shows
the average profitability across firms over time. ROAs and profit margins declined during the GFC. In
the subsequent recovery, both profitability measures rebounded and increased steadily until 2014
when the negative commodity price shock hit the economy. Nevertheless, both profitability
measures remained close to average (ROAs) or slightly above (profit margins). Overall, profitability in

NEW ZEALAND
the economic expansion after the GFC Figure 2. Recent Development of Firm Performance
appears to be somewhat stronger Indicators
than in the 3 years before
the GFC. 2
6. At the industry level, there

was a broad tendency toward
stronger profitability after the GFC.
Broadly speaking, more productive
industries had higher ROAs and, in
many cases, higher profit margins
after the GFC. The comparison by
industry also suggests that
investment was stronger in high
productivity sectors and a tendency
toward lower leverage after the GFC. Sources: Orbis; and IMF staff calculations.
As for leverage (liabilities to assets),
industries with lower productivity rankings have reduced leverage more than others since the GFC.
In contrast, industries with higher productivity rankings saw higher leverage and investment after
the GFC. Overall, this evidence seems consistent with greater scrutiny on firm performance for credit
extension after the GFC.
7. A similar picture emerges at the firm level (Figure 3). Looking at the same variables from
a firm-level rather than an industry perspective suggests that the profitability of New Zealand firms
increased after the GFC on average. Leverage ratios, in contrast, declined in general after the GFC,
with the distribution across firms becoming more bimodal. This implies that some firms improved
profitability with higher leverage and other firms with lower leverage. Another noteworthy feature of
the data is larger firms tended to have higher leverage and display stronger investment growth. The
performance of some large firms notwithstanding, the growth rate of capital investment in nominal
terms turned from being positive before the GFC to being negative on average after the GFC.
2
The short sample period before the GFC is due to the lack of data.

NEW ZEALAND
Figure 3. Leverage, Investment and Profitability Before and After the GFC
Before the GFC After the GFC
4
4
Capital Investment Growth (%)
Capital Investment Growth (%)

2
2
0
0
-2
-2
-4
-4
0 .2 .4 .6 .8 1 0 .2 .4 .6 .8 1
Leverage Leverage

60
60
40
40
Profit Margin (%)
Profit Margin (%)
20
20
0
0
-20
-20
-40
-40
0 .2 .4 .6 .8 1
0 .2 .4 .6 .8 1 Leverage
Leverage

40
40
20
20
ROA (%)
ROA (%)
0
0
-20
-20
-40
-40
0 .2 .4 .6 .8 1 0 .2 .4 .6 .8 1
Leverage Leverage
Note: The sample is scaled by total assets. Financial companies are excluded. The sample is trimmed at the
mean plus/minus 2 times standard deviation of capital investment, profit margin and ROA.
Sources: Orbis; and IMF staff calculations.

NEW ZEALAND
8. High-leveraged firms reduced leverage and investment after the GFC. The stylized facts
at the firm and industry levels suggest a tendency toward lower leverage and investment after the
GFC. To examine whether pre-GFC leverage was indeed a driving force in firm behavior and
performance after the GFC, whether above average leverage before the GFC has had predictive
content for post-GFC changes in the variables discussed so far is examined. Table 1 shows the
results of a regression of the changes in various firm variables on the initial leverage levels in 2007
immediately before the GFC. The regression includes industry-dummies, to control for differences in
leverage across industries. The firm variables examined include changes in leverage, ROA, and profit
margin from 2007 to 2016, as well as changes in the average investment growth rate before and
after the GFC. The results in Table 1 shows that the coefficients on leverage are negative and
statistically significant at the 1 percent level for leverage and investment growth. The negative
coefficient on initial leverage condition implies that firms whose leverage had been above average
pre-GFC deleveraged after the GFC. A similar story holds for investment.
Table 1. Pooled OLS Regression Results with Industry Fixed Effects

Dependent ∆Leverage2016-2007 ∆ROA2016-2007 ∆Profit Margin2016- ∆Average Investment
Variable 2007 Growth after GFC-before GFC
Leveragei,j,2007 -0.373*** (0.037) -4.355 (2.793) -4.154 (2.770) -3.49×108***

(1.21×108)
Constant 0.157*** (0.022) 1.511 (1.608) -2.047 (1.554) 3.42×108*** (6.97×107)
Observations 708 689 635 629
Note: ***Statistically significant at the 1 percent level. Standard errors are in parentheses.
Source: Orbis; and IMF staff estimates.
9. R&D expenses are positively correlated with profitability for firms at the productivity
frontier. Another important driver of productivity is R&D. Figure 4 shows the relationship between
firm performance, as measured by the ROA, and R&D intensity, defined as the share of R&D
expenses in operating expenses. The relationship is compared between firms at the productivity
frontier and other firms. The former are firms in industries in which productivity growth and
profitability (ROA) are both relatively high in New Zealand. The relevant frontier industries include
information technology, transportation, agriculture, wholesale and retail, and real estate industries
(see Figure 1). Figure 4 highlights the positive correlation between profitability and R&D intensity in
the case of frontier firms. This supports the idea that R&D activity enhances innovation, which leads
to higher productivity. By contrast, the correlation between R&D and ROA is negative in the case of
other firms. Put differently, R&D in the latter does not necessarily lead to higher firm performance in
New Zealand. This may imply the limited R&D capability of New Zealand firms in non-frontier
industries. This result is consistent with the finding by Wakeman and Conway (2017) who also find
that the relative returns of innovating firms are generally negative among the least productive New
Zealand firms. Thus, it could be important to increase the R&D capability of non-frontier firms to
raise productivity in New Zealand.

NEW ZEALAND
Figure 4. Productivity Frontier versus Non-Frontier Firms
Frontier Non-Frontier
100
100
50
50
ROA (%)
ROA (%)
0
0
-50
-50
-100
-100
0 .2 .4 .6 .8 0 .2 .4 .6 .8 1
R&D Intensity R&D Intensity
Source: Orbis; and IMF staff calculations.
10. Lower leveraged-firms spend more

Figure 5. R&D Intensity and Leverage
on R&D. Finally, the relationship between R&D
and leverage is investigated because financing
1
conditions can affect R&D activity. Figure 5

shows a negative correlation between leverage
.8
and R&D spending. This implies that low-

R&D Intensity
.6
leveraged firms tend to invest more in R&D.

Although the causal relationship between these
.4
two variables is not investigated, a possible

explanation is that low-leveraged firms are
.2
deemed to be less credit constrained and they

0
have more room for investing in innovative 0 .2 .4

Leverage
.6 .8 1
activity.
Sources: Orbis; and IMF staff calculations.
C. Conclusion
11. A firm-level analysis of profitability, leverage, and investment in New Zealand

suggests that a general tendency toward stronger firm profitability after the GFC. The firm
profitability measures used in the analysis are considered proxy variables for productivity
performance. At the same time, firms generally reduced leverage after the GFC, except for some
larger firms, suggesting that leverage may have increased too much before the GFC. For many firms,
the flipside to reduced leverage was reduced capital investment. At the industry level, there is some
evidence that credit and investment have shifted toward industries with higher productivity growth.
Furthermore, R&D expenses are positively correlated with profitability in firms that are at the
productivity frontier, but not in other firms. Overall, these findings would be consistent with the view
that there has been increased scrutiny in credit extension after the GFC and a lower willingness for
firms to take on risks, including from smaller firms.

NEW ZEALAND
References
Chappell, N. and A. Jaffe, 2018, “Intangible Investment and Firm Performance,” Review of Industrial
Organization 52: 509-559.
Doan, T., D. Maré and K. Iyer, 2015, “Productivity Spillovers from Foreign Direct Investment in New
Zealand,” New Zealand Economic Papers 49: 249-275.
Fabling, R. and L. Sanderson, 2013, “Exporting and Firm Performance: Market Entry, Investment and
Expansion,” Journal of International Economics 89: 422-431.
Hong, S., L. Oxley, P. McCann and T. Le, 2016, “Why Firm Size Matters: Investigating the Drivers of
Innovation and Economic Performance in New Zealand Using the Business Operations
Survey,” Applied Economics 48: 5379-5395.
Le, T. and A. Jaffe, 2017, “The Impact of R&D Subsidy on Innovation: Evidence from New Zealand
Firms,” Economics of Innovation and New Technology 26: 429-452.
Maré, D. and D. Graham, 2013, “Agglomeration Elasticities and Firm Heterogeneity,” Journal of Urban
Economics 75: 44-56.
McCann, P., 2009, “Economic Geography, Globalisation and New Zealand’s Productivity Paradox,”
New Zealand Economic Papers 43: 279-314.
Smith, D., J. Chen and H. Anderson, 2012, “The Relationship Between Capital Structure and Product
Markets: Evidence from New Zealand,” Review of Quantitative Finance and Accounting 38: 1-
24.
Wakeman, S. and P. Conway, 2017, “Innovation and the Performance of New Zealand Firms,” New
Zealand Productivity Commission Staff Working Paper 2017/2.

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IMF Country Report No.

Copies of this report are available to the public from

International Monetary Fund • Publication Services

International Monetary Fund

© 2018 International Monetary Fund

Approved By Prepared by Dirk Muir, Ryota Nakatani, Yu Ching Wong (all

INFRASTRUCTURE INVESTMENT IN NEW ZEALAND: GAPS AND MULTIPLIER

REVAMPING INFLATION TARGETING IN NEW ZEALAND 30 YEARS AFTER ITS

HOUSING AFFORDABILITY IN NEW ZEALAND AND POLICY RESPONSE__________________ 35

2 INTERNATIONAL MONETARY FUND

PRODUCTIVITY AND PROFITABILITY IN NEW ZEALAND: THE ROLE OF LEVERAGE, R&D,

INTERNATIONAL MONETARY FUND 3

INFRASTRUCTURE INVESTMENT IN NEW ZEALAND:

• Closing the infrastructure investment gap is analyzed using ANZIMF (Australia-New

o The government could take the opportunity to further regional development. By

4 INTERNATIONAL MONETARY FUND

1. There has been an increased emphasis by the government on infrastructure spending.

2. The extent of the infrastructure investment gap is an important question, because it

B. A Baseline for the Infrastructure Investment Gap

INTERNATIONAL MONETARY FUND 5

Box 1. The Six Step Methodology of the Global Infrastructure Outlook

Infrastructure investment gap = investment needs – current trends in investment

6 INTERNATIONAL MONETARY FUND

Figure 1. Global Infrastructure Needs versus Figure 2. Infrastructure Needs versus

Figure 3. Infrastructure Components Figure 4. Infrastructure Investment

INTERNATIONAL MONETARY FUND 7

8. An aggregate infrastructure investment gap as a share of GDP is constructed from

• The placement of infrastructure is based on current patterns of urbanization. Most

8 INTERNATIONAL MONETARY FUND

C. Benefits from Closing the Infrastructure Investment Gap

ANZIMF is an annual, multi-region, micro-founded general equilibrium model of the global

INTERNATIONAL MONETARY FUND 9

10 INTERNATIONAL MONETARY FUND

INTERNATIONAL MONETARY FUND 11

Figure 5. Closing the Baseline Infrastructure Investment Gap by 2040

Note: The bar marked “SS” is the steady-state value.

12 INTERNATIONAL MONETARY FUND

D. Closing the Gap as a Tool for Fiscal Policy

Focus on Closing the Gap Sooner

19. The government could Figure 6. Infrastructure Investment Gaps

INTERNATIONAL MONETARY FUND 13

Figure 7. Closing the Gap Earlier

Note: The bar marked “SS” is the steady-state value.

14 INTERNATIONAL MONETARY FUND

Focus on Furthering Regional Development

25. Regions in need of further

INTERNATIONAL MONETARY FUND 15

16 INTERNATIONAL MONETARY FUND

• Repeat the population-weighted distribution of infrastructure investment, but with an

INTERNATIONAL MONETARY FUND 17

Focus on Improving the Quality of Infrastructure Investment

Table 2. Infrastructure Quality Scores Figure 9. Matching Infrastructure Quality in

Airports 5.6 6.9

Ports 5.5 6.7

Rail 3.5 5.9

Roads 4.7 6.3

18 INTERNATIONAL MONETARY FUND

INTERNATIONAL MONETARY FUND 19

• Improving the quality of infrastructure investment. An illustrative example is presented

20 INTERNATIONAL MONETARY FUND

INTERNATIONAL MONETARY FUND 21

22 INTERNATIONAL MONETARY FUND

REVAMPING INFLATION TARGETING IN NEW